Your Money Matters More

The final installment (Taxes)

The final installment in this series on cash flow relates to making your tax rate work for you.There is no legal way around paying taxes.  However, you are not required to pay more than your share and there are ways to use the tax code to reduce that share.  As always, the goal is to maximize your cash flow with as little effort as possible.

The first line of defense is to using an employer sponsored retir  ement plan such as a 401k or 403b if available to you.  We all want to retire someday, so it is never too early to begin saving towards that goal. These contributions are tax deferred until retirement when you would optimally be in a lower tax bracket.  Once again, make sure that your contribution is equal to that which your employer matches. 

If you don’t have access to one speak with your Certified Financial Planner for the most appropriate IRA for your needs.  She can compare Roth versus traditional IRA to find the best alternative for your tax bracket.  Don’t make the financial mistake of assuming you don’t have enough money to save some money.  Over time that savings compounds and your tax rate will be less when you do retire and use the money.

Don’t treat your taxes like a saving account.  Your refund is not a windfall.  The government has been using your money for twelve months.  Over this year, you could have been using your money to your advantage.  Look at your budget, determine which of your expenditures tax impacted, for instance are, if you have a large amount of prescription cost and your company provides a 125 Plan or a Health Savings Account allocate money to these plans. They are pre-tax and as long as you expense the money for medical cost they are never taxed. However, the difference between the two is that 125 plans are use it or lose it, so be aware of what you have to spend and what qualifies as a medical expense. An advantage to the HSA is that it behaves much like an IRA in that if it is not used, it rolls over and is tax deferred.

A tax savings idea for those with a family is a college saving in a 529 plan.  These allow you to make a contribution after-tax which grows tax free as long as it is spent for education. All fifty states offer these plans, but you need to speak with your CFP because some States offer additional benefits in state taxes for these plans.

Taxes provide services beyond what fire trucks and police cars.  Knowing the tax code and using a CFP to help you maximize the benefits within can help you today as you plan for the future. 

Prospero Financial Planning can help visit our website at www.ProsperoFP.com

Retirement is Personal

Retirement is personal:  it can be an elusive goal or it can be a well -planned gift to yourself after a long career.  There are key milestones in this process. To avoid tax penalty waiting until you reach the age of fifty-nine and a half to take distributions from your qualified plan maximize your benefit. Contribute the maximum matched dollar value—the more the better—and keep it invested.  When you do reach fifty-nine and a half you have more options. Remember though, fifty-mine and a half is a number; retirement is a goal.

 

To avoid any penalty from a qualified plan your birthdays count. Once you are fifty-nine and a half, there is no longer a penalty to remove your money, but your money can still work for you if you leave it.  The penalty is considerable: it not only becomes taxable income, but there is an additional ten percent tax on the amount of the withdrawal. Conversely, if your money is not in a qualified plan these restrictions do not apply…you will have already paid tax each year as it accrued but you will have less to invest and you will have less accumulating tax defered. As always, talk to a Certified Financial Planner (CFP) before making any move.

Putting away the maximum dollar amount matched by your employer makes you less dependent on the rate of return as your investment accumulates funds. If you can add other moneys to this amount they too can grow tax deferred. The tax deferral allows you to accumulate money faster. For example if your 401(k) is being invested at the rate of $3,000 a year, you are not only saving the whole $3,000, but you are also compounding interest on that investment tax defered. If you are able to leave it until you are fifty-nine and a half, you will not pay tax until it is distributed.

Waiting until you are at the optimal age, you can take the entire amount or you can take any amount you need to live on and let the balance ride.  Determine with your CFP what supports your lifestyle. You can control your taxable income by controlling your distributions. The ability to combine your defined contribution plans gives you better economy of scale when it comes to selecting your investments, also.  

Although fifth-nine and a half is the point where penalties no longer occur, retiring later can have even greater benefit.  Your CFP can walk you through these options based on your personal financial standing. Begin planning as soon as possible to allow for the optimal benefit when using a defined contribution plan.  When the time is right—enjoy! 

6 Steps to reduce your income tax for this year

1. Max out your at least your matched retirement plan deductible contributions
2. Recognize any capital losses in your taxable accounts
3. Prepay as many deductible expenses in this tax year
4. Make as many non-cash contributions to charity that you can (Including that old broken down car that you no longer need)
5. Have an accounting of medical expenses ready for your tax preparer including prescriptions, deductibles and direct medical expenses
6. Have an accounting of your miscellaneous expenses that include moving expenses and non-reimbursed business expenses

If you have done as many of these items as you can you will be better prepared when it comes to the time for filing your income taxes!

Financial Rules of Thumb

I have relied on general rules of thumb for the financial well being of clients.

Financial security results by adhering to basic principles:

Controlling Debt
    o Not exceeding 20% of your net worth (excluding the mortgage and net equity in the home)

Housing Costs
    o should not exceed 28% of your net income
    o includes all the expenses related to your house

Emergency Fund
    o Represents three to six months living expenses
    o Should be liquid and not volatile
This would include your money markets, short-term bond funds, and other cash equivalents.

Retirement Funding
    o Contribute 6% on a pretax basis to an IRA or a 401(k)
    o Or 8% funded on an after tax basis

Following these four steps should result in the accumulation of enough wealth to retire comfortably

If you would like more ideas contact.:

Charles T Shearman, CFP

Prospero Financial Planning
23 S 8th Street, Suite 3400
Noblesville, IN 46060
Work (317) 774-5136

www.prosperofp.com

 

Simple IRA

Overview

If you need to have a basic retirement plan, one with limited paperwork maybe a simple IRA is for you. With a simple IRA you have the increased contribution levels with much additional paperwork. With contributions up to $12,000 with a catch-up provision of an additional $2500 for those over 50, these are fairly attractive plans without much in the way of paperwork. Overall they provide for low-cost  operation with increased contribution limits.

Prosess

1. Fill out an IRA application
2. Adopt a prototype
3. Fill out an Employer Agreement
4. Contribute

 

Buy Smart

    I have always had medical professionals as clients. One thing this has taught me is that being smart enough to pass med school doesn’t necessarily translate into financial intelligence. Doctors, as well as any professionals who have a steadily increasing salary at the start of their careers, can often make purchases that hurt their cash flow down the road once their income plateaus. This makes it all the more important to develop an emergency or “slush” fund early in your career no matter what your occupation. Then later in life, once your rainy day money has grown, the finer things are less of a strain on your bank account. The two main purchases that can set an individual up for financial distress are expensive cars and big houses. Making the right buys can lead to a life of comfort, if done correctly.

 

Fancy Cars 

 

When individuals jump up into the six figure income bracket one of the first things they want to do is buy an expensive new car. What they fail to realize is that when they drive their so called “investment” off the lot, it loses thousands in value immediately. Their new car will then continue to lose value until the wheels fall off. But Chuck, “How am I supposed to show off my financial superiority while I’m on the go?” It’s  simple. Buy used. Say you think you would look nice in a Mercedes-Benz SLK350. You’ve worked hard to bring in the money and its time to reward yourself. A new SLK350 costs over $55,000. A used last year model costs $36,000. Paying an extra nineteen grand for that “new car” smell seems quite ridiculous. Any other investment that declined in value by 35% its first year would make you furious. Even for individuals with more modest tastes, a Honda Civic loses four thousand in its first year off the lot which is still a 20% decrease. Do yourself a favor and let someone else be the sucker who has to unload their bad investment in a year’s time.

 

Living Large 

 

The other mistake many make is purchasing a house that is too big early in their careers. If your job is putting fat stacks in your slacks the worst thing you can do is tie yourself down to a house that will pull cash out of your pocket for the next fifteen to thirty years. We at Prospero Financial always push to develop a solid emergency account before purchasing an expensive home. Buying a less expensive home allows you to build that emergency fund faster.  You will then be able to make a larger down payment on your next home. This will give you more equity to build on. You will need 20% equity in the property in order to avoid private mortgage insurance and decrease your mortgage payment.

 As unpredictable as the housing market is, you want to make sure that your house and property are sellable when the time comes. Choosing your neighborhood wisely can make a huge difference in the future. Picking the right house in that neighborhood can be just as important. The most expensive house in a neighborhood will be the hardest to sell. When prices in housing go up your palace might increase in value, but a home is worth nothing if there’s no one to buy it. The cheapest house in the neighborhood can be just as tough. Look for a home that is in the upper middle price range for the neighborhood you are moving into and you will have made a safe choice if you ever need to liquidate the property. Lastly, when  it comes time to sell a house, you need to leave yourself at least six months time to keep from leaving money on the table. Selling a home can be profitable, as long as you make smart decisions along the way.

Related articles

The Millennial Home Buying Guide

Should You Buy a New Home or Older Home?

Not Ready To Retire Yet?

 I was looking around my networking group and it seemed to be made up of a large group of people on their second or third careers due to company downsizing. They probably had a retirement plan, 403(b) for not-for-profit entities or 401(k) for any other entities, after leaving a previous employer.  They may be spending this to maintain their lifestyle and that's probably alright as long as that doesn't go on for very long. It is better to reduce your lifestyle then drain your retirement plans.  You not only don’t have the money for the retirement years you also don’t get the growth on that money that you withdraw from these accounts.   

Not only do you pay tax on the withdrawls but this can be doubly bad if you're paying tax penalties on an IRA or 401(k).  The IRS may charge a 10% premium to withdraw funds.  This is if you haven't reached the age of 59½.  There are several exceptions to the age 59½ rule. Even if individuals receive a distribution before they are age 59½, they may not have to pay the 10% additional tax if they receive a distribution from a retirement plan (other than an IRA) after leaving a job and are age 55 (age 50 for qualified public safety employees).  Or they are receiving a series of distributions in equal payments based on your life expectancy.  These are not the only exceptions but those most likely to apply.    

Another way to avoid the 10% penalty is to prove hardship. A retirement plan may (but is not required to) allow participants to receive hardship distributions. A distribution from a participant’s elective deferral account can only be made if the distribution is because of an immediate and heavy financial need, and limited to the amount necessary to satisfy that financial need.  

You should consult your tax Advisor before you undertake this.

Case Study in Retirement Planning - Part 2

In Part 1, we established the Jack and Diane Davis family and their current net worth.  In this, Part 2, we will address gifting to their soon-to-be-born grandchild.  There are a variety of ways to accomplish this and not pay any gift tax.  And since they have more income than will be needed in their retirement they wish to make a gift to their grandchild.

 

Gifting Options

• One option they can use is their annual exclusion.  This amounts to $13,000 each, or a total of $26,000 for the couple.  Since they will be buying Christmas and birthday presents throughout the year, it's not advisable to use all of this credit.  They would probably want to use $25,500 at a maximum.  This can be done each year for each grandchild from this point forward.  This needs to be a "present value" gift.  In other words, this needs to be money they can spend, i.e. cash. 

• Another option is to use their one-time credit that ultimately totals $1 million for each spouse, and then it will be gone.  Right now it might seem excessive, but the child will have many years to receive gifts and this is better reserved for a future time, or when they can do some form of "leveraged gifting.” 

• “Leveraged gifting” means that something that is valued at than $1 today will only use $1 of the lifetime credit.  Since the value of things is calculated at the time of the gift, now would be an ideal time to do this, when the market has not fully recovered, and prices are depressed.  Leveraged gifting involves either giving a future interest in something, or something that has its value decreased by its container, i.e., a family limited partnership.  The reason a future value gift is not worth dollar-for-dollar is because it has delayed gratification to it.  A problem with these gifts is they may never be completed, and they have the ability to get sucked back into your estate.  These may take the form of a Grantor Retained Income Trust (GRIT).  In other words, the grantor retains the right to the income during his/her lifetime, or a specified number of years.  The longer the term, the greater the discount.  This is just one type of leveraged gifting. 

• Wrapping these gifts in a partnership which has a general partner and limited partnership interest is another form of discounting.  These are discounted because they have strings attached.  In other words, because of the restrictions placed on the beneficiary, the gifts can't just be spent or sold.  Real estate and business interests are often ideal assets for this type of entity.  It makes it easily dividable into units to distribute among the children.  For example, Jack could take the stocks in the furniture store and divide them among the children, giving a limited partnership to all the children, and the general partnership to only those children involved in the business.  Or he can retain the general partnership interests, thus retaining control of the partnership. 

These are only a few of the endless possibilities for gifting.  In fact, I have seen some individuals who have used these techniques to keep the family together at holidays by holding board meetings in exotic locations!  And this arrangement is advantageous for tax reasons too. 

I will expand on this subject in future articles.  For now, suffice it to say that Jack and Diane have a multitude of good options they can choose.

 

Case Study in Retirement Planning - Part 1

This is the first in a series of blogs that will follow a couple, called Jack and Diane, who are approaching retirement.

 

Family Background

Jack is a business owner, and Diane is an anesthesiologist.  They have four children, one of whom is a special needs child. This gives us ample fodder for this series of articles that we are going to do in this blog.  Following this couple from age 50 through the birth of their first grandchild and business planning succession, funding of their retirement, estate planning and estate equalization for those children who don't work in the business.  They will also need to make provisions for the special-needs child.  And they will also develop some lifetime gifting programs.

Through this blog, you can follow the couple as they journey through the many facets of retirement and estate planning.  Please stay connected to learn how all of these things are accomplished to help Jack and Diane arrive at retirement with their financial arrangements in order and a sense of well-earned peace of mind.

Diane participates in a 403(b) plan at her work for a not-for-profit hospital.  Her annual salary is $250,000.  Jack has amassed a large portion of his money in a 401(k).  His annual salary through the furniture store he owns is $175,000.

Family Statistics

John (Jack) Davis, age 50, furniture store owner

Diane Davis, age 50, anesthesiologist, member of anesthesiology group

Child:  Gregory, age 25, married, no children – is involved in furniture business

Child:  Lynn, age 23, married, expecting first child – not involved in furniture business

Child:  Allison, age 20, in college, working part-time at furniture business

Child:  Timothy, age 16, special-needs child

 

Jack and Diane's Balance Sheet

Assets
Jack’s 401(k)	$350,000
Diane’s 403(b)	$450,000
Furniture Store	$1,750,000
Primary Residence	$450,000
Investments	$200,000
Duplex (rental property)	$125,000
Personal Property	$225,000
Total	$3,550,000
Liabilities
Mortgage on Residence	$250,000
Mortgage on Duplex	$125,000
Total	$375,000
Net Worth	$3,175,000

 

 

 

Since this is the first in a series of articles, Be sure to check back and stay tuned to see how we deal with family and business issues and successfully bring Jack and Diane to retirement.