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Tax Rates and Brackets

Tax Rates and Brackets

This is meant to illustrate how confidence wealth can help with financial planning.

Tax Rates

Income Taxes

The United States’ tax system is progressive, which means that the greater your income the greater the tax that you pay on it. Many reasons exist for why your taxes are structured in this way. Essentially, the U.S. tax code is designed to recognize and address income inequality.

Currently, there are seven tax brackets in the U.S. These brackets are structured around your annual income for a given tax year. Please see the table below for an illustration of how these rates are set to work.

Tax Rate % Tax Bracket/Annual Income Tax Owed
10 Up to $9,525 10 Percent of Taxable Income
12 $9,526 to $38,700 $952.50 plus 12% of the amount over $9,525
22 $38,701 to $82,500 $4,453.50 plus 22% of the amount over $38,700
24 $82,501 to $157,500 $14,089.50 plus 24% of the amount over $82,500
32 $157,501 to $200,000 $32,089.50 plus 32% of the amount over $157,500
35 $200,001 to $500,000 $45,689.50 plus 35% of the amount over $200,000
37 $500,001 or more $150,689.50 plus 37% of the amount over $500,000

There are four ways you can file, which represents your tax status:

  1. Single
  2. Married, filing jointly
  3. Married, filing separately
  4. Head of Household

Here’s an example of your tax obligation if you file as single:

  • $9,524 at 10 percent=$952.40
  • The next $29,175 at 12 percent=$3,501
  • The final $11,301 at 22 percent=$2,486

Your taxes due at the end of the calendar year would be $6,939. If you apply the total taxable amount against annual income, your effective tax bracket is 13.9 percent.

The good news here is that you do not have to spend any time calculating your tax bracket because software programs handle that for you. For many people, an accountant is the individual who is asked to prepare tax return forms and those forms include all the calculations as well.

To the extent that you can invest in a tax-advantaged way, you should do so. Your best interests would be served by engaging with a financial advisor who will help you put together a short- or long-term investing plan. A wealth management plan will do its best to navigate your investments in a way that takes advantage of tax rules. By setting up a formal financial plan with an advisor, you are giving yourself the best possible hope, despite taxes, of having a successful outcome.

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Uses of Life Insurance

This picture helps depict the text having to do with uses of life insurance

Uses of Life Insurance

Ways of using life insurance

A permanent, whole-life insurance policy may be used to provide income to the beneficiary, or beneficiaries, at time of death. Most of us know and understand this. This is the primary function of a life insurance policy.

But a whole life policy has other uses, as well. Here, it’s important to make a distinction between a permanent policy and a term policy. Term is far more limiting in the uses it may serve, outside of offering up a death benefit. Term policies certainly come with advantages, no doubt. But only with a permanent policy may you put in place creative financial solutions in such a way that the policy has many more uses other than providing death benefits. Several of these are listed below.

  1. Cash flow. While it generally takes a whole life policy up to 10 years to begin generating cash flow, you can borrow against your policy much sooner. This method of generating cash flow is perhaps one of the most commonly understood advantages of a whole life policy. This is true because the life insurance industry, appropriately, goes out of its way to let policyholders know that this is a salient feature of how they can be used and why they should be purchased. Usually, you can pay the company back, with interest. Or you can have the loan amount deducted from the death benefit. As with all of these options, you should speak with an advisor before you decide to pursue a life insurance policy loan.
  2. Living benefits. Many newer policies now come with what are called “living benefits.” What this means, literally, is that you can access benefits, or policy payments, if certain afflictions develop regarding your health, without death being the trigger. These kinds of health issues usually surround whether you are critically or terminally ill or injured. Living benefits may be offered under term policies, but they are usually characterized in different ways from a whole life policy. Perhaps the best term here is “accelerated benefit riders.” However defined, these benefit options allow should allow you great flexibility should you have an unexpected need for cash.
  3. Tax shelter. The investment growth in a life insurance policy is tax-sheltered. That means that the investment return inside of your policy is not subject to taxation. It is allowed to continue growing (different kinds of investment alternatives exist and must be fully understood) tax-free.
  4. Estate preservation. If set up properly, the amount you pay in premiums to your policy may be deducted by your estate, thus limiting the amount of taxes you pay. Tax-free cash is available once the policyholder passes away and these payments may be used by heirs to cover estate taxes.
  5. Cash value for death benefits. If your policy permits, you may take your accumulated cash value and use it to purchase a greater death benefit. In this instance, rather than take a distribution of cash available to you, this amount can “go back” into the policy to increase the amount of death benefit that will be available to the policy beneficiary. The ability of your policy to offer this option is important, and you should carefully consider purchasing a policy that will not provide this level of benefit flexibility.
  6. There are numerous other advantages to purchasing life insurance. These far exceed the core reason, which is to provide for heirs at time of death. Many of these have to do with accessing the cash value portion of your policy. If there is one key provision of a life insurance policy, it is likely its ability to build a cash value that you can access for any number of reasons. These include loans to start a business or college education expenses.

Ways of using life insurance

It is important for you to understand the creative uses that life insurance policies offer. They are able to accomplish much more for you financially than simply paying burial expenses and providing income to your heirs. Know enough about them to know that you should seek out the advice of an experienced financial consultant before making any policy decisions.

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Tax-Advantaged Investments

What Are Tax-Advantaged Investments?

This image is meant to help define tax-advantaged investing

Tax-Advantaged Investments

 

Tax-Advantaged Investments

You’ve most likely heard the term “tax-advantaged” investments. And you may have wondered what kinds of investments fall into this category. Turns out, more than you might imagine. What’s also important to know is that you should explore these options and use them where they make sense.

It’s an obvious statement, but a tax-advantaged investment is any investment that provides a level of tax relief that other, dissimilar investments do not. Using these investment options will allow your money to accumulate more rapidly than otherwise. Following is an overview of selected tax-advantaged investments. It is not meant to be all-encompassing. It excludes real estate investments, which possess distinct tax advantages. The focus here is on the multitude of investment options that may be less familiar than real estate but are no less important and worthwhile.

Tax-Advantaged Investments

Municipal bonds: Sometimes referred to as “munis,” these are debt investments issued by federal and state and local governments that generate interest-free dividends. The interest rates they pay are federal tax-free and, if you live in the state where issued, usually tax-free there as well.

Employer-sponsored retirement plans: These are most commonly referred to as 401(k) plans (although similar arrangements exist under different IRS plan codes, such as 403(b) for non-profit organizations and 457(b) plans for governmental workers) and they allow your contributions into the plan to be deducted from your paycheck on a pre-tax basis. If you elect to contribute to a 401(k) plan and defer, for example, $5,000 a year, that amount will be contributed to the plan before any income tax is assessed. If you make $30,000 a year you will only be taxed on $25,000, a substantial tax break. The greater the contribution the greater the savings. On top of this, your investment will grow tax-free until you begin taking distributions. In theory, your tax bracket will be lower in retirement than it is now because you will, by default, be making less money. Being free of any tax during its accumulation, your account balance will grow more quickly than if you lose a certain percentage each year because of taxes.

Traditional IRA (Individual Retirement Account): IRAs are not new at all. They have been around for decades. An IRA is still one of the best tax-advantaged investments available to you. You set up an IRA and then contribute to it with after-tax dollars. Those contributions are usually tax-deductible. For tax year 2019, you may contribute up to $6,000 or $7,000 if you are over age 50. You may invest in a wide array of choices, including mutual funds and fixed-rate CDs. Your investment gains are not taxed until you begin to take distributions, and these distributions have rules connected to them. Withdrawals that take place in violation of these rules will typically be assessed a penalty.

Roth IRA: The Roth IRA has not been around as long as traditional IRA’s, but it offers up significant tax advantages as well. Roth contributions (but not earnings) may be withdrawn at any time. Contribution limits are the same as with an IRA. Contributions to a Roth IRA are not tax-deductible, but accumulations are not taxed. If you hold the account for five years, you may begin to take tax-free distributions (IRAs work just the opposite) because you’ve already paid taxes on the contribution. Even earnings from a Roth are not taxed at distribution. This is truly a distinctive feature, and it represents one compelling reason, among others, why you should ask your advisor about the Roth IRA.

Health Savings Accounts (HSA): If you are enrolled in a high-deductible health insurance plan (HDHP), as defined by the government, you can qualify for an HSA. Many health insurance providers will offer you the opportunity to participate in an HSA. You do so by deciding how much you want to contribute each year. For 2019 the limit is $3,500. Contributions are made on a pre-tax basis and earnings grow tax-free. Each year you may rollover your account balance if you choose, so your contributions will not be “lost” if unused. Investment growth is not taxable. Distributions from an HSA are not taxable after age 65, at which point you can use the asset to help cover Medicare costs.

Tax-Advantaged Investments

All these tax-advantaged options are worth a good look. They all offer distinct advantages that will allow you to put your money to the greatest possible use, which is another way of saying that when you are investing for the future you want to shield as much of that investment from taxation as possible. Some may be more suitable than others. You should ask your advisor which options are the best for you.

 

 

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Budget or Financial Plan

Why you need both a budget and a financial plan

Budget or Financial Plan

You Need Both a Budget and a Financial Plan

Budget or financial plan: it’s not “or,” it’s both.

Most of us know what a budget is, whether we follow one or not. Is a budget different in any material way from a financial plan? The answer, of course, is yes.

The term “financial plan” may be a bit confusing because many individuals and families have never actually established, or initiated, one. To add to the confusion, there are many misconceptions about what a true financial plan is or isn’t.

For example, while there might be some overlap between a budget and a financial plan, it’s important to know that the two are distinctively different. Your budget helps you keep tabs on your monthly spending habits to understand the full picture of your expenses and how much room, if any, you have left over at the end of the month: “room” here meaning available dollars for saving and investing. Your budget is a monthly liability versus asset reckoning.

Budget or Financial Plan?

Your financial plan, on the other hand, is a roadmap to your financial future; it tells you exactly what you need to do with your money every month to maintain your lifestyle and at the same time save for the future. It can contain implications of immediacy, but by its nature it is long-term in concept and creation.

The financial plan is not, though, a set-it-and-forget-it exercise. It’s also not a quick fix for your finances. Nor is it something only for the older or wealthy. It’s not synonymous with a wealth management plan, but they both strive to do accomplish the same results.

In this article, you’ll learn what a financial plan is, what it can do for you and why you’ll need one to achieve a comfortable financial future. And your budget informs nearly everything the plan is about.

The goal of any financial plan is to align your monthly budget—altered where necessary—with your long-term financial goals, and most of these have to do with how much money you’ll have for retirement.

Budget or Financial Plan?

Your budget is today and tomorrow and next week. Your financial plan is three, five, maybe thirty years down the road.

In other words, think of the financial plan as an instrument that may (or may not) allow you to maintain your current way of life while saving to maintain as much of it as possible when you no longer receive work-related income. Since this may be an awfully big goal, your financial plan needs to address financial strategy and tactics, and much of the latter will need to confront how you invest your money.

While a good financial plan encompasses much more than investing, investing remains the foundation of any plan, and this is essential to building your wealth over time. For this reason, it’s the most commonly recognized part of a financial plan. Investing, and investing wisely, are what will help you achieve your financial goals later in life. Remember, the financial plan will help get you to as close a satisfying retirement as possible.

Budget or Financial Plan?

To do this, the sound financial plan will always begin with a highly detailed inventory of your current financial position, and it will bring into play the all-important budget we’ve been discussing. It’s safe to say that your budget lies at or near the center of your financial plan—it informs what will become your financial plan. And if your budget changes—for example, you get a raise at work—at the next review of your financial plan, this new and highly important information will be incorporated into the next iteration of the financial plan.

Resistance to a financial plan often has to do with the sacrifices we may need to make now. Will I still be able to dine out three times a week? What about other areas of entertainment? Movies? Concerts? Can I maintain my current lifestyle?

Again, it depends. If your income is sufficient to support these and still save thoroughly for retirement, then perhaps you can continue living the way you do now. But what if you can? Wouldn’t it make sense to cut back on some of your expenses so you could increase your retirement savings dollars? Would you rather retire with, say, $150,000 more in your 401(k) by skipping a few nights out for dinner? And, understand this: over even short amounts of time these “sacrifices” can make a big difference in your retirement income.

Budget or Financial Plan?

Here’s what the prudent individual will do. Create a monthly budget that you can adhere to, one you can stick with for one year. Then, build your financial plan around that budget. Save as much as you can; sacrifice where sacrifice does not hurt you in any serious way. Then, create a new budget at the end of year one and ask your advisor if any changes need to be made to your financial plan because of any significant budget changes.

In the long run, these actions make a difference. These actions will enhance your retirement years, which is the goal of us all: to be able to stop working without too much sacrifice in what we enjoy doing. So, build your budget, see a planner, and be smart about retirement.

 

 

 

 

 

 

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The Alternative Minimum Income Tax (AMT)

The Alternative Minimum Income Tax

 

picture represents the alternative minimum income tax

The Alternative Minimum Income Tax

Simply put, the Alternative Minimum Income Tax (AMT) is a tax on the wealthy. Or maybe not. It’s a tax on individuals whose income tax liability benefits from certain deductions and exclusions unavailable to those with lesser incomes. The AMT, which used to be called the tax on the rich, traces its beginnings to the late 1960s.

Then, a congressional report was released that showed quite a few high-income earners paid little or no taxes, and they did so because of their ability to use the tax code for deductions others could not access—much of this having to do with the capital gains tax. Public outcry was loud and angry. How could this be, many wondered? What happened was simply that certain high-income earners used tax laws to reduce or eliminate their taxes—and who’s to blame them. If tax loopholes exist, they tend to exist to be exploited. That’s the way these things work.

But it wasn’t until a decade later, in 1979, that Congress addressed this issue: lawmakers effectively lowered the barriers for AMT coverage. The AMT was established as a parallel tax to ordinary income taxes. You calculated your tax under standard rules. Then you calculated your tax under the AMT; you paid the higher of the two which, for high earners, was inevitably the AMT. It was a tax that had the weight of this following saying: “you can run but you can’t hide.”

The AMT was a stopgap tax that kept the wealthy from under-paying on their taxes, and there was, and is, no way around it. But it’s not what it used to be.

Currently, there are seven federal income tax rates, the high being 39.6 percent. With the AMT, there are two rates: 26 percent and 28 percent. The two tax computations—regular and AMT—run parallel to each other; in a sense they complement each other. An individual who might be subject to the AMT must first run his or her tax according to the regular tax structure, with all seven brackets. Then, that person runs his or her AMT (jointly if that is the filing status). The higher of the two taxable amounts is what must be paid.

The AMT also contains exemption amounts, which are higher than the standard deductions under “normal” tax rules.

Over the years, especially the last 2-3 years, the amount of income that can be preserved under the AMT has grown. The AMT calculation and brackets are always going to be subject to the prevailing politics of the day. This is for certain: they will increase; they will decrease.

Currently, the AMT takes away certain income tax breaks available under existing law. The following deductions have vanished:

  • Various itemized deductions;
  • All dependent exemptions;
  • Normal or regular income exemptions;
  • State and local income taxes; and
  • Home equity deductions.

One of the problems with the AMT is that it was never indexed for inflation. So as incomes have naturally risen along with the Consumer Price Index, more and more individuals are subject to the AMT.

Multiple factors go into determining if you are subject to the AMT. It’s hard to determine whether you’re subject to it or not, at least without using an accountant or a sophisticated tax preparation software.

Beginning in 2018 the AMT does adjust for inflation. You are subject to the tax, if married and filing jointly, if your income is above $109,400.

To try and avoid the AMT you should do at least two things: increase your savings into any tax-advantaged vehicles available and increase charitable giving. This may not relieve you from the AMT, but then again it may. Stay focused on the AMT. Know where the exemption levels lie and do your best during the tax year to avoid the AMT altogether.

 

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Bond Market Investments: Looking for Income

Bond Market Investments: Looking for Income

 

The image contains information on investing and investing in bonds

Bond Market Investments

It’s no secret that interest rates have been at all-time lows since their historic highs of the late 1970s. At the height of the interest rate increases of forty years ago in the late 1970s and early 1980s, the Fed Funds rate exceeded 20 percent. The Fed Funds rate is the interest rate at which banks can borrow short-term money, usually overnight, from each other to keep the debt markets liquid. It sets the tone for interest rates in general across all interest-sensitive investments.

Bond Market Investments.

During the economic collapse of 2008 and early 2009, the Fed Funds rate was zero, meaning that the cost of money was, effectively, free. Why? Because the Fed either raises or lowers rates to help stabilize the economy; it raises or lower rates either to slow or increase economic growth. It’s a safety valve for the economy and it is used judiciously because of its power. It’s safe to say that the various Fed Chairmen and Chair Janet Yellen have been cautious and conservative over the years, as they should be, always attempting to calibrate the effect of rates on the equity and debt markets—and, by extension, the economy at large.

Altering the Fed Funds rate is a powerful economic tool: its impact on the economy is substantial and consequential.

Bond Market Investments.

Which brings us to bond market investments and whether they make sense, right now. The answer, wouldn’t you know it, is that it depends. It depends on what you are trying to accomplish with your investing plan. Bond interest rates differ according to the maturity of the bond in question: short-term bond maturities will have lower interest rates than longer-term debt investments. But the differences are not always as dramatic as you’d expect. With longer-term debt investments, you tend to be rewarded for the length of time you are willing to tie up your money.

You’d think, if you didn’t know otherwise, that the difference between 5-year treasuries and 30-year treasuries would be extensive. That is not necessarily the case.

For those considering bond market investments, think about this. The rate on 5-year treasuries today is 2.26 percent. The interest rate on a 30-year treasury bond today is 2.86 percent. Pause to consider. Usually, the longer the maturity of a bond the higher the rate, and usually by a considerable amount. When this is the case the bond yield curve is said to be normal.

In an inverted curve yield market, shorter-term bond rates are higher than long term bond instruments. This, of course, is counterintuitive. If you’re willing to take on a longer maturity bond, you should be rewarded by doing so: which is to say your interest rate should be higher than on a short-term bond investment. Today, we are in a flat yield curve environment. This defines the illustration above: there is very little difference between yields on short- and long-term bond or debt investments. (Stock ownership is referred to as equity investing.)

So, let’s get back to the “it depends” part of this piece on bond market investments. Does it make sense to invest in bonds, given the flat yield curve we are experiencing?

If you are looking to add yield, or interest rate payments, to your portfolio it likely does make sense to put some—repeat, some—of your money in a bond investment or in an investment tied to the bond market, like a bank CD. You should know, however, that with rates as low as they are at banks these days, you’ll need to keep an eye out on inflation, which is not a major issue today. If a 5-year bank CD pays, as it does, about 3 percent, you may barely be keeping up with inflation. The current rate of inflation is slightly over 1 percent. So, given all this, your money in a short-term bond investment will beat inflation, which is a good thing.

But here’s a second view to consider. Let’s say you are investing for income, which means you are looking for interest income. If you do so through a mutual fund government securities portfolio your interest rate will likely be higher than the numbers above. Those rates can be in the 6 percent range. Not bad, given the historically low-interest rates we are experiencing now.

But remember this: bond market investments will not only pay you interest but may cause you to lose principal. Why? Because as the interest rates on bonds increase, their underlying price falls. (Exclude CDs, where your money is guaranteed, but locked up for varying periods of time.) This means that, contrary to what many investors think, you can lose money in a bond investment! If yields go up, the underlying price falls; if yields go down, the underlying price rises. Which means you can make money, too.

Here’s an example. You put your money in a government securities mutual fund with a yield, which can change daily, of 4.5 percent. Your original investment is $10,000. If rates on government securities (treasury bonds) go up, your $10,000 investment will drop. The higher the rate increase the steeper the drop. With bonds, principal and interest move in inverse relation to each other. Of course, as noted, you can avoid this by putting your money in a CD, where the principal is guaranteed not to decline—but then your money is locked up and you lose liquidity, if that’s important to you.

Stories abound about individuals who invested in the bond market for income, only to find that interest rates slipped up and the actual value of their investment dropped. Sure, the investor is receiving the interest rate payments, but if or when he or she decides to sell in a market such as this, they will not recover their principal investment, which has shocked more than a few investors.

The best way to view this is as follows.

Be prepared to reallocate assets as quickly as possible. You do not want to lose principal when you are investing for income, but you can do just that if you’re not aware of all the elements at work.

Also, we all know that the one thing you can’t predict is the direction of the economy.

Bond Market Investments.

You need to invest both for income and growth. But don’t think for a moment your principal is protected if you invest in bonds, whether directly or through a mutual fund.

In the end, this all goes back to investing 101: know where your money is, know the consequences of that money should the economy begin to worsen, and know that you can and should make changes in consultation with your advisor.

 

 

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Social Security and COLA Increases

The History of Social Security and COLA Increases

Social Security as we know it today was born in January 1940, under President Franklin D.  Roosevelt. According to the Social Security Administration web site, the first recipient was Ms. Ida May Fuller of Vermont, a legal secretary. Her first monthly check was for $22.54, and ten years later she was still drawing the same amount each month.

Social Security and COLA Increases.

Clearly, at the dawn of one of this country’s strongest social safety nets no one gave much thought to inflation—to the concept that living expenses generally increase each year and that a fixed monthly draw need not have any payment “escalators” built in. One reason was that low levels of payroll taxes were in place to provide for annual increases. Simply not enough money was being collected to pay more than minimum monthly payments, and these were not contemplated to increase beyond the initial amount.

Legislative changes took place in 1950 that sought to address what was an obvious deficiency. For the first time, benefit increases were put into place, but not systematically; they were not raised every year, automatically. Recipients had their monthly benefits recomputed back to when they were first received. Ms. Fuller’s monthly benefit lurched from $22.54 to $41.30, quite an increase. (She lived to be 100 and the sum of her lifetime benefits totaled $22,888.92.)

It would take a few years later before increases were put in place annually.

Social Security and COLA Increases.

Automatic Cost of Living Allowances (COLAs) were put into place in 1975. They were established to offset the ravages of inflation. Interest rates were high and going higher, and the elderly could not sustain themselves on fixed incomes, unless they were fortunate to have pensions—and even then, inflation was devouring their monthly incomes.

The Social Security COLA for 2019 is 2.8 percent. At first glance, this would seem fair. The annual CPI for 2018 was 1.9 percent. Even though one percent above inflation is not large, there are those who would argue that Social Security’s COLA outstrips the annual cost-per-living index and that that is sufficient. That much is true. But those numbers do not tell the complete story.

Take, as merely one example, costs the elderly pay that younger individuals generally do not. These would include the costs for Medicare. Each year costs under that health program typically exceed inflation. And it’s not just healthcare insurance-related costs. Look at this chart reprinted from Think Advisor:

The costs of all these items are not exclusive to the elderly. But many are. Look at the percentage increases over the period of eighteen years. For overall medical costs, 123 percent; for prescription drugs, 253 percent.

Now look at the Social Security cost of living allowances over the same eighteen-year period:

Year Social Security Increase Percentage
2000 3.5
2001 2.6
2002 1.4
2003 2.1
2004 2.7
2005 4.1
2006 3.3
2007 2.3
2008 5.8
2009 0.0
2010 0.0
2011 3.6
2012 1.7
2013 1.5
2014 1.7
2015 0.0
2016 0.3
2017 2.0
2018 2.8

 

It’s clear that Social Security COLAs haven’t come close to keeping up with annual expenses largely borne by the elderly.

And then there’s taxation of Social Security benefits. Once you arrive at your normal retirement age, Social Security payments are not taxed.

Social Security and COLA Increases.

Before that, however, single tax filers who make from $25,000 to $34,000 will need to pay a tax rate of fifty percent on their Social Security payments. If you make over $34,000 annually then you’ll pay taxes at a rate of 85 percent. If you’re married and file jointly, then you’ll pay a 50 percent income tax rate on income between $32,000 and $44,000. You’ll pay 85 percent if your combined income is more than $44,000.

Social Security advocates contend that these taxes are too steep on payments that have such low COLAs built in annually.

So, what’s the point here?

The point is that financial and wealth planning are needed to address these deficiencies. The greater your assets in retirement plans and pensions, in IRAs, in separate savings accounts, the greater your chances that low cost of living increases and taxes on Social Security will not harm you irreparably.

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Budget and a Financial Plan: You Need Both

You Need Both a Budget and a Financial Plan

Describes the reason for a budget and a financial plan

Budget and a Financial Plan

Budget or financial plan: it’s not “or,” it’s both.

Most of us know what a budget is, whether we follow one or not. Is a budget different in any material way from a financial plan? The answer, of course, is yes.

The term “financial plan” may be a bit confusing because many individuals and families have never actually established, or initiated, one. To add to the confusion, there are a lot of misconceptions about what a true financial plan is or isn’t.

For example, while there might be some overlap between a budget and a financial plan, it’s important to know that the two are distinctively different. Your budget helps you keep tabs on your monthly spending habits to understand the full picture of your expenses and how much room, if any, you have left over at the end of the month: “room” here meaning available dollars for saving and investing. Your budget is a monthly liability versus asset reckoning.

Budget or Financial Plan?

Your financial plan, on the other hand, is a roadmap to your financial future; it tells you exactly what you need to do on a monthly basis to maintain your lifestyle and at the same time save for the future. It can contain implications of immediacy, but by its nature it is long-term in concept and creation.

The financial plan is not, though, a set-it-and-forget-it exercise. It’s also not a quick fix for your finances. Nor is it something only for the older or wealthy. It’s not synonymous with a wealth management plan, but they both strive to do accomplish the same results.

In this article, you’ll learn what a financial plan is, what it can do for you and why you’ll need one to achieve a comfortable financial future. And your budget informs nearly everything the plan is about.

The goal of any financial plan is to align your monthly budget—altered where necessary—with your long-term financial goals, and most of these have to do with how much money you’ll have for retirement.

Budget or Financial Plan?

Your budget is today and tomorrow and next week. Your financial plan is three, five, maybe thirty years down the road.

In other words, think of the financial plan as an instrument that may (or may not) allow you to maintain your current way of life while saving to maintain as much of it as possible when you no longer receive work-related income. Since this may be an awfully big goal, your financial plan needs to address financial strategy and tactics, and much of the latter will need to confront how you invest your money.

While a good financial plan encompasses much more than investing, investing remains the foundation of any plan, and this is essential to building your wealth over time. For this reason, it’s the most commonly recognized part of a financial plan. Investing, and investing wisely, are what will help you achieve your financial goals later in life. Remember, the financial plan will help get you to as close a satisfying retirement as possible.

Budget or Financial Plan?

To do this, the sound financial plan will always begin with a highly detailed inventory of your current financial position, and it will bring into play the all-important budget we’ve been discussing. It’s safe to say that your budget lies at or near the center of your financial plan—it informs what will become your financial plan. And if your budget changes—for example, you get a raise at work—at the next review of your financial plan, this new and highly important information will be incorporated into the next iteration of the financial plan.

Resistance to a financial plan often has to do with the sacrifices we may need to make now. Will I still be able to dine out three times a week? What about other areas of entertainment? Movies? Concerts? Can I maintain my current lifestyle?

Again, it depends. If your income is sufficient to support these and still save thoroughly for retirement, then perhaps you can continue living the way you do now. But what if you can? Wouldn’t it make sense to cut back on some of your expenses so you could increase your retirement savings dollars? Would you rather retire with, say, $150,000 more in your 401(k) by skipping a few nights out for dinner? And, understand this, over even short amounts of time these “sacrifices” can make a big difference in your retirement income.

Budget or Financial Plan?

Here’s what the prudent individual will do. Create a monthly budget that you can adhere to, one you can stick with for one year. Then, build your financial plan around that budget. Save as much as you can; sacrifice where sacrifice does not hurt you in any serious way. Then, create a new budget at the end of one your and ask your advisor if any changes need to be made to your financial plan because of any significant budget changes.

In the long run, these actions make a difference. These actions will enhance your retirement years, which is the goal of us all: to be able to stop working without too much sacrifice in what we enjoy doing. So, build your budget, see a planner, and be smart about retirement.

 

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Saving for Retirement: Start Yesterday

Start Saving for Retirement Yesterday

Social security alone will not get us through our retired years

Saving for Retirement

There’s a pending catastrophe in this country whose origins began in 1946 and ended, roughly, in 1964. These are the baby boom years. The war was over, and men and women wanted to get on with their lives and start building their futures. They did so by, among other things, having children. Lots of children. It’s estimated that today there are somewhere between 70 and 80 million baby boomers in the country. Some are quite old; others are just now entering their sixties.

These individuals have been putting a strain on several key social safety net programs put in place, in many ways, dating back to the Franklin D.Roosevelt administration but also back to President Lyndon Johnson and his Great Society initiatives in the 60s. These include, principally, Social Security and Medicare. The latter of these is not so much the subject of this piece. The former, Social Security, is.

Saving for Retirement

The average Social Security monthly payout is slightly under $1,500 dollars. Think about that for a moment. Let’s say you had an on-and-off working career, for whatever reasons. Or say that your lifetime wage was never what anyone would call generous. Either of those translates to a low Social Security payout. (An important component of your Social Security payout is predicated on lifetime earnings.) And even if your Social Security payout is considerably larger than the average, unless you have access to significant other financial resources, most of your income in retirement will derive from Social Security. You may have a pension, and if so good for you. You may have a fat 401(k) account—good for you, too.

But no matter your income, and no matter your sources of income, these days you can expect to live a long time after you turn 60-years old. A 60-year old male who does not smoke is expected to live to slightly beyond age 84! That’s 24 years. And during those 24 years, if you represent the average individual, you will get sick and sicker (not meant to be depressing but an expression of reality). So even though Medicare, assuming it goes largely unchanged from today, will cover most of those expenses. But not all. Even with Medicare, you’re still responsible for a portion of your medical bills and monthly payments into the system.

Social Security was never meant to be the principal source of income in a person’s retired life. It was meant to augment other sources of income—income from retirement plans, IRAs, personal savings and investments. All of these, even though they have existed only for about the last 40 years or so. But the proliferation of retirement programs, set in place by the Employee Retirement Income Security Act (ERISA) of 1974, has not provided the relief many expected.

From Nerd Wallet, here’s a 401(k) account balance by age groups:

Ages 20-29:

Average 401(k) balance: $11,600.

Median 401(k) balance: $4,000.

 Ages 30-39:

Average 401(k) balance: $43,600.

Median 401(k) balance: $16,500

Ages 40-49:

Average 401(k) balance: $106,200.

Median 401(k) balance: $36,900.

Ages 50-59:

Average 401(k) balance: $179,100.

Median 401(k) balance: $62,700.

Ages 60-69:

Average 401(k) balance: $198,600.

Median 401(k) balance: $63,000.

It is, of course, not surprising that the higher your age, the higher your account balance. But still, look closely at the numbers and you’ll see that savings through our retired lives are woefully low.

Again, from Nerd Wallet: the average IRA balance is approximately $97 thousand. Of course, not all (401(k) savers have IRAs.

Saving for Retirement

So, imagine this: You are age 59 and you have $179 thousand in a 401(k) and $97 thousand in an IRA. That’s $276 thousand in savings for retirement. This same individual is, actuarially, likely to live another 25 years. Assuming no growth in any of these accounts, or loss, that leaves this hypothetical individual with slightly over $11 thousand per year to live off. Then, add in the average Social Security balance and this individual is “earning” a monthly income of slightly over $12 thousand. This will barely cover the rent on a one-bedroom apartment in most cities and even in rural areas.

There’s a moral here and it’s shockingly obvious. Baby boomers will likely not have enough time to save sufficiently for retirement. Starting at age 60 is too late; it’s also too late to start at age 50. This post is not meant to address any legislative changes that may need to be instituted to assist these individuals. Maybe our lawmakers will somehow take this issue up, or maybe not.

But no one should rely on help from that arena.

Start saving for retirement as early as possible. Encourage younger individuals to begin to save now for retirement (although that can be a daunting task; we generally do not do well at thinking this far ahead when we’re younger).

Here’s an example:

 

Initial Deposit Savings Frequency/Amount Years Rate of Return Amount Earned/Saved
$5,000 Monthly/$100 5 7 percent $13,923
$5,000 Monthly/$100 10 7 Percent $26,429

 

In this scenario, saving an additional five years more than doubled the five-year savings total. This reflects the power of saving for retirement as early as possible. The trick is to do so wherever possible in tax-advantaged arrangements such as employer-sponsored retirement programs, IRAs, Roth IRAs, Keogh if self-employed—any of these is good and will help you significantly in your retirement years. And it’s almost never too late: start today, whether you’re 35 years old or 65 years old.

As the expression goes, you’ll be glad you did.

 

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Estate Planning and the Portability Provision

show a family enjoying the benefits of sound estate planning

Estate Planning

Estate Planning and Estate Preservation

Estate Planning and the DSUE or the Portability Allowance

Estate planning is necessarily complex, and the greater the wealth at play the greater the need for complexity. This is not an activity left to a novice. Genuine and thorough estate planning must be performed by trained and experienced professionals. A lifetime of wealth accumulation should not be treated lightly when it comes to its disposition—that is, taxation—at death. A well-executed and formal estate plan can save millions for an individual’s family and loved ones. “Well-executed” means that details are not overlooked. “Well-executed” means that all financial eventualities be considered and accounted for. Finally, it means the planner is immersed in estate planning practices and knows important details that must be considered, whether employed in the final plan or not.

Estate Planning and DSUE

One important part of any estate planning work, when married individuals are reviewing their estate options, is something called the DSUE, or “deceased spouse’s unused exclusion.” DSUE is also referred to as the portability provision or allowance. Using one term or another does not change the meaning of the provision at all. In the broadest possible terms, when it comes to estate planning, portability simply means “porting over” from a deceased spouse to a surviving spouse any unused estate tax exemption. This provision was enacted eight years ago in legislation known as The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010. In 2013 legislation, portability was extended indefinitely.

Before Portability

Before portability became law, married couples needed to set up a by-pass or credit shelter trust. These would be a repository for the deceased’s unused estate tax exemption. This preserved the assets from taxes—thereby eliminating double taxation—on the subsequent death of the surviving spouse. If the deceased spouse had any available estate tax exclusion left, it was effectively lost. Portability addressed that problem.

The Estate Tax Exemption

Simply put, the estate tax exemption allows an individual to preserve certain assets from taxation at time of death. Over long periods of time, this exemption has changed significantly. For tax year 2019, the IRS announced that the exemption will equal, per individual, $11.4 million. This amount, indexed annually to the inflation rate, is scheduled to be phased out of existence in 2025. What new dollar level will exist in 2025 would be anybody’s guess. Once an individual, not married, exhausts his or her exemption, the remainder is taxed at 40 percent.

Under these exemption rules, a married couple would collectively have an exemption of $22.8 million in 2019.

Here is a list of estate tax exemptions and the estate tax rate for the last eight years:

 

Year Estate Tax Exemption Estate Tax Rate
2012 $5,120,000 35.0%
2013 $5,250,000 40.0%
2014 $5,340,000 40.0%
2015 $5,430,000 40.0%
2016 $5,450,000 40.0%
2017 $5,490,000 40.0%
2018 $11,180,000 40.0%
2019 $11,400,000 40.0%

Here’s an example, without using DSUE. It’s the year 2018, and John, not married, passes away. John has an estate at death valued at $16.5 million. Earlier he set up an estate plan—and established a like provision in his will—within which he desired to have his assets at death to be split evenly between his two brothers, Bill and Josh. Of the $16.5 million, $11,180,000 is excluded from taxes. John’s taxable estate is thus $5,320,000 ($16.5 million minus $11.18 million). What remains is taxed at 40 percent, meaning the two brothers share equally in the remaining 60 percent ($5,320,000 times .6 equals $3,192,000).

Here’s how the assets look after John’s death. Bill and Josh both will inherit $5,590,00 with no tax penalty ($11,180,000 times .5). Plus, each will receive 50 percent of what is left after the 40 percent estate tax rate on $5,320,000, or $1,596,000 each. The total to each brother equals $7,186,000 ($5,590,000 plus $1,596,000).

This hypothetical calculation does not bring the portability provision, or DSUE, into play at all.

Here’s the significant point from the example above: taxes at death have a consequential impact on what our heirs get to keep at the point of inheritance. Also note this: certain states, but only a few, have chosen not to follow federal statutes and may have rules far more restrictive. A well-done and comprehensive estate plan will look at all applicable rules, federal and state, and take these into account. Otherwise, the likelihood for unnecessary tax exposure increases while inheritance dollars may take a significant and unnecessary hit. A qualified and conscientious wealth management strategist will help you avoid any miscues.

So, how does DSUE truly work?

Estate Planning: Porting Over Excess Exemption Dollars

In brief, here’s what DSUE, or portability, means. It allows an executor, or a specifically designated individual, to elect to file a decedent’s estate tax return in such a way that it “ports” to the surviving spouse any unused estate tax exemption. Rules exist for the filing of this estate tax return. A knowledgeable estate planning professional will make certain these filing requirements are met. Generally, the estate tax exemption DSUE form must be filed within nine months of the spouse’s death.

Let’s take John again, but under different circumstances. In this example, he’s married to Anne. This time, John has an estate valued at $15 million. Anne’s estate is valued at $13 million. John and Anne have two children, Mary and Adam. Several years earlier the couple put together an estate/financial plan that deliberately incorporated portability. John dies in 2018 and Anne, his executrix, files an estate tax return that formally establishes portability (it’s a specific tax form issued by the Internal Revenue Service). Without being overly simplistic, this allows Anne to retain the amount of the estate tax exclusion that John did not use.

It works like this.

In 2018, John dies. His estate tax exclusion for that year would have been $11,180,000. He used none of it in the form of gifts; he died with his full exemption intact. Anne, by virtue of the planning the two had undertaken, becomes the recipient of all her deceased husband’s exemption. She now has her tax exemption, which in 2019 is $11,400,000, plus John’s exemption from 2018 ($11,180,000) which is when Anne filed the portability tax forms. Her total estate exemption is, therefore, $22,580,000 (which includes John’s exemption of $11,180,000 the year he died). Both John and Anne, in 2019, are now deceased. John’s estate is still valued at $15 million and Anne’s at $13 million. Total estate assets are $28 million.

Children Mary and Adam are designated as 50/50 recipients of their parent’s estates. Their total estate tax exemption will be John’s 2018 exempt amount of $11,180,000 plus Anne’s 2019 exemption amount of $11,400,000. The total is $22,580,000. This amount goes to the children free of estate taxes. The difference between the full value of the estate, $28 million, and their collective exemption of $22,580,000 is $5,420,000. This is taxed at 40 percent, leaving the children with 60 percent.

Mary and Adam both will share equally in the following: $22,580,000 plus $3,252,000. Each, accordingly, receives $12,916,000, net. Wealth at this level, and certainly higher, cannot be preserved inter-generationally without the kind of necessary and sophisticated estate planning that takes available rules and allowances into account.

Generally, in the case where there are multiple spouses, the individual filing for portability must use the estate valuation numbers of the most recent spouse to die.

Estate Planning: Summary

There are no margins when it comes to estate planning. The knowledgeable planner will be fully knowledgeable of, and conversant with, all relevant principals at play for individuals undergoing the process. Mistakes can cost millions. Planner ingenuity can save millions. Do not take this exercise lightly. Seek out expert planners. Ask for references. Proactively ask about the portability provision: it can save and your beneficiaries millions.