While our government struggles to get its financial house in order, perhaps there is a lesson for all of us from what is happening in Washington.
I do not think any of us really ever want to reach the point where we say, “How did it get this way? How did it get this bad?” So what to do – just a few simple steps to make sure your financial house is in order:
1. Risk Management
(A) Long Term Disability Coverage (Income Replacement insurance) – Whether you are single, married, divorced – it does not matter – just make sure you have adequate Long Term Disability coverage in place. In the event a disability stops you from working due to an illness or injury, you need to maximize your income. A disability could cause not only loss of income, but also loss of health insurance, loss of retirement benefits, increase health costs, etc. And the typical group plan only covers a portion of your income and that benefit is typically going to be taxable income to you. You need to have supplemental coverage from a highly rated company.
(B) Life Insurance – this discussion may depend on your family situation. But even if you are single, but plan to have a family, getting coverage while you are young and healthy may be an advantage. Too many times, a person waits and then later has a medical issue that either prevents them from getting coverage or makes it more expensive. With a family, life insurance is a must. A great rule of thumb here is that for every $1,000 of after tax monthly income you want to provide to a surviving spouse, you need $250,000 of death benefit in place. And when factoring in inflation, this sum will typically last the survivor about 20 years. So calculate the after tax monthly needs for your family and make sure you have adequate life insurance in place.
Lastly, don’t discount the value of a non-working spouse. Imagine the expenses if a stay at home Mom or Dad were not around. Non-working spouses need coverage too. A rule of thumb here – $250,000 of coverage on the non working spouse for each child.
(C) Cash – build up a reserve of about 3 months income and keep it in readily accessible cash. Use a money market or similar account that is safe and secure.
2. Wealth Accumulation
Once Risk Management issues are resolve, the next step in planning for your financial house is wealth accumulation:
(A) Retirement Planning – Utilize your company 401(k) plans or pensions. If there is a matching contribution on behalf of your company, then at least contribute enough to maximize the company match. If there is a Roth option, use it. Conventional wisdom tells us that tax rates have nowhere to go but UP. If you believe this, then the old paradigm of straight tax deferral must be changed. You need to move as much as possible from Tax Deferred vehicles into Tax Free vehicles. Roth 401(k)’s provide this regardless of income level. Roth IRA’s do as well. For those that make too much to contribute on their own to Roth IRA’s (single – $122,000 of Adjusted Gross Income, and Married filing jointly – $179,000 of Adjusted Gross Income), the tax laws currently allow a non-deductible contribution to a traditional IRA and then the ability to convert it into a Roth IRA (regardless of your income level).
This is a great way to move money into the Tax Free category for your retirement. Another Tax Free vehicle is a Permanent Life Insurance policy, which has a tax free build up of cash inside the policy.
(B) Saving for Retirement vs. Saving for Colle ge– Plan for retirement first, then move on to college. “You cannot take out a loan for your retirement”. Use this as your mantra. There are multiple ways for kids to get to college – paying out of pocket (at a time when parent’s income should be at or near its highest), loans, scholarship, and God forbid, they can work during college. That is not true at retirement, and obviously you want to NOT WORK during retirement. So save, save, save for retirement first.
(C) College Savings – Use 529 College Savings plans – these are vehicles that require after tax contributions, but have tax free growth of the dollars inside the plan. As long as the funds are used for college expenses (as defined by each state’s plan), then there is no tax on the growth. However, if the funds are not used for college, the growth (not your original contributions) are taxed at your ordinary income rate and assessed a 10% penalty. If not using 529 accounts, then you are left with saving in a taxable account. If that account is in the parents’ name, then any growth will be taxed at the parents’ tax rates. Consider a custodial account, in the child’s name, and then growth will be taxed at the child’s rate.
3. Wealth Preservation and Distribution – this is a fancy name for Estate Planning. Simply put, once you have worked so hard to accumulate wealth, the goal is to preserve it and prevent it from being taxed as you use it for retirement, bequeath it to charity, or pass it along to the next generation. There are many techniques for doing this, included using trusts and other tax shelters to accomplish the goal of tax avoidance, too many to enumerate here. Safe to say, make sure you have update Wills, Trusts, and health care documents (Living Wills, Durable Powers of Attorney, Do Not Resuscitate Orders, etc). Contact your Attorney and Financial Advisor to consider the best strategies for you.
And no discussion of wealth preservation would be complete without mentioning Long Term Care Insurance. With the rising cost of health care and nursing care, Long Term Care insurance is a must to preserve family assets. Again, consult your Financial Advisor or Insurance Professional to discuss.
With these basic steps, you can do what the U.S. Government never seems to be able to do – get your financial house in order. Act now, don’t delay. You don’t want a “default” for your family. Happy Planning!
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