Tag Archives: Taxes

Tax Planning

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“It may feel good at tax time to get a refund, but remember that the money you’re getting back is money you loaned the government at no interest.”

Benjamin Franklin famously said, “nothing is certain but death and taxes.” Skip filing your taxes, and the tax agents will come calling. And when they do, you’ll likely face penalties and interest — and even lose your chance to receive a tax refund.

Unless your income is below a certain level, you will have to file federal income tax returns and pay taxes each year. Therefore, it’s important to understand your obligations and the way in which taxes are calculated.

Every year, everyone who makes money in the U.S. must fill out a prior calendar year tax return and file it with the IRS by April 15th. The process inspires dread among anyone who performs this task without the help of an accountant. The forms are complicated, and the definitions of terms like “dependent” and “exemption” can be difficult to understand.

Tax Basics and Taxable Income

There are two types of income subject to taxation: earned income and unearned income. Earned income includes:

  • Salary
  • Wages
  • Tips
  • Commissions
  • Bonuses
  • Unemployment benefits
  • Sick pay
  • Some noncash fringe benefits

Taxable unearned income includes:

  • Interest
  • Dividends
  • Profit from the sale of assets
  • Business and farm income
  • Rents
  • Royalties
  • Gambling winnings
  • Alimony

It is possible to reduce taxable income by contributing to a retirement account like a 401(k) or an IRA.

A person can exclude some income from taxation by using a standard deduction amount determined by the government and a person’s filing status or by itemizing certain types of expenses. Allowable itemized expenses include mortgage interest, state and local taxes, charitable contributions, and medical expenses.

Anyone can make an honest mistake with regard to taxes, but the IRS can be quite strict. And since everyone’s tax situation is a little different, you may have questions.

Allowed Deductions – Deductions and Tax Exemptions

The IRS offers Americans a variety of tax credits and deductions that can legally reduce how much you’ll owe. All Americans should know what deductions and credits they’re eligible for — not knowing is like leaving money on the table.

Most people take the standard deduction available to them when filing taxes to avoid providing proof of all of the purchases they’ve made throughout the year. Besides, itemized deductions often don’t add up to more than the standard deduction.

But if you’ve made substantial payments for mortgage interest, property taxes, medical expenses, local and state taxes or have made major charitable contributions, it could be worth it to take this step. These tax deductions are subtracted from your adjusted gross income, which reduces your taxable income.

The government allows the deduction of some types of expenses from a person’s adjusted gross income, or gross income minus adjustments. A person can exclude some income from taxation by using a standard deduction amount determined by the government and a person’s filing status or by itemizing certain types of expenses. Allowable itemized expenses include mortgage interest, a capped amount of state and local taxes, charitable contributions, and medical expenses.

Depending on who you are and what you do, you may be eligible for any number of tax deductions and exemptions to reduce your taxable income. At the end of the day, these could have a significant impact on your tax exposure. Starting with the standard deduction, the links below will help you determine how to shrink your income — for tax purposes, of course.

Common Tax Credits

Tax credits are also another way to reduce your tax exposure and possibly obtain a tax refund when the dust settles. Many people don’t realize that a tax credit is the equivalent of free money. Tax deductions reduce the amount of taxable income you can claim, and tax credits reduce the tax you owe and, in many cases, result in a nice refund.

The IRS offers a large number of tax credits that encompass everything from buying energy-efficient products for your home to health insurance premium payments to being in a low- to moderate-income household. The key to benefiting from these credits is examining all of the purchases you’ve made throughout the year to see if you are owed money.

There are 17 tax credits for individuals you can take advantage of in five categories:

  • Education credits
  • Family tax credits
  • Healthcare credits
  • Homeownership and real estate credits
  • Income and savings credits

Taxes: What to Pay and When

Most Americans don’t look forward to tax season. But the refund that a majority of taxpayers get can make the tedious process of tax filing worth the effort.

When you’re an employee, it’s your employer’s responsibility to withhold federal, state, and any local income taxes and send that withholding to the IRS, state, and locality. Those payments to the IRS are your prepayments on your expected tax liability when you file your tax return. Your Form W-2 has the withholding information for the year.

The U.S. has a pay-as-you-go taxation system. Just as income tax is withheld from employees every pay period and sent to the IRS, the estimated tax paid quarterly helps the government maintain a reliable schedule of income. It also protects you from having to cough up all the dough at once.

When you file, if you prepaid more than you owe, you get some back. If you prepaid too little, you have to make up the difference and pay more. And, if you’re like most wage earners, you get a nice refund at tax time.

But if you are self-employed, or if you have income other than your salary, you may need to pay estimated taxes each quarter to square your tax bill with Uncle Sam. You may owe estimated taxes if you receive income that isn’t subject to withholding, such as:

  • Interest income
  • Dividends
  • Gains from sales of stock or other assets
  • Earnings from a business
  • Alimony that is taxable

So, it’s important to remember that taxes are a pay-as-you-go. This means that you need to pay most of your tax during the year, as you receive income, rather than paying at the end of the year.

There are two ways to pay tax:

  • Withholding from your pay, your pension or certain government payments, such as Social Security.
  • Making quarterly estimated tax payments during the year.

This will help you avoid a surprise tax bill when you file your return. If you want to avoid a large tax bill, you may need to change your withholding. Changes in your life, such as marriage, divorce, working a second job, running a side business or receiving any other income without withholding can affect the amount of tax you owe.

And if you work as an employee, you don’t have to make estimated tax payments if you have more tax withheld from your paycheck. This may be an option if you also have a side job or a part-time business.

It may feel good at tax time to get a refund, but remember that the money you’re getting back is money you loaned the government at no interest.

References:

  1. https://www.nerdwallet.com/article/taxes/tax-planning
  2. https://www.findlaw.com/tax/federal-taxes/filing-taxes.html
  3. https://www.findlaw.com/tax/federal-taxes/tax-basics-a-beginners-guide-to-taxes.html
  4. https://turbotax.intuit.com/tax-tips/small-business-taxes/estimated-taxes-how-to-determine-what-to-pay-and-when/L3OPIbJNw
  5. https://www.moneycrashers.com/paying-estimated-tax-payments-online-irs
  6. https://www.irs.gov/payments/pay-as-you-go-so-you-wont-owe-a-guide-to-withholding-estimated-taxes-and-ways-to-avoid-the-estimated-tax-penalty

Inflationary Pressures are a Real and Present Concern

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“Inflation jumped 5 percent in the past year, the fastest pace in 13 years.”

Inflation in the US has jumped to the highest rate since 2008.  For the past decade, inflation has averaged under 2 percent a year. But suddenly, inflation is rising much faster than anticipated and planned by the Federal Reserve. For instance, inflation rose 5 percent between May 2020 and May 2021, the Labor Department reported.

Inflation results when demand exceeds supply in an economy. When the economy grows faster than its ability to provide goods and services demanded by consumers, prices rise. When the economy grows more slowly than its potential growth rate, prices tend to fall. Factors that affect an economy’s growth rate include the supply of labor and the productivity of those workers.

Inflation is imply defined as the price of a good or service increasing over time. Conversely, you can also define inflation by looking at the value of the dollars purchasing those goods and services. Said another way, while you might agreed that the price of good and services have increased, you can also state the dollars you spend now purchase less quantity of goods and services … and by extension, the dollars themselves are clearly worth less.

Money supply and budget deficits

We’ve learned that inflation is, “always and everywhere a monetary phenomenon,” according to economist Milton Friedman. Money supply growth is a requirement, but in and of itself, it’s not enough to cause inflation. The money needs to find its way into the economy and turnover rapidly to generate inflation. (This is referred to as the velocity of money or ratio of M2 money supply to gross domestic product, or GDP.) In recent years, the velocity of money has fallen sharply.

Rising budget deficits are not necessarily linked to inflation, either, but can contribute to an overheating economy. It all depends on whether it stimulates demand to exceed supply. From a long-term perspective, there has been little correlation in recent years between the level of debt in the economy and inflation.

The causes of present inflation and the primary explanations are:

  • Pent-up demand following the COVID-19 shutdown.
  • Base effects (essentially older low values rolling off).
  • A massive increase in the supply of dollars.

Rising Prices 

“Inflation is taxation without legislation.” – Milton Friedman.

With commodity prices soaring, money supply growth exploding, and government spending surging, there is a palpable fear of a return to 1970s-style inflation. I get it. I remember those times.

Core inflation, which strips out volatile items such as food and energy, leaped to the highest level since 1992. It rose 3.8% year-on-year, up from 3% in April.
Other official data showed that the number of initial claims for jobless benefits fell to its lowest since mid-March 2020, when the first wave of Covid-19 hit.

The cost of used cars and trucks climbed 7.3% in May from April, accounting for a third of the increase in inflation. Prices were 29.7% higher than a year earlier. They have risen in recent months because of a global semiconductor shortage that has held back car production, pushing people to enter the market for second-hand vehicles instead.

Energy prices rose, by 28.5% year-on-year, including a 56% jump in gasoline prices compared with May 2020, when demand slumped due to the pandemic. And, gasoline prices are destined to go higher with the cancelation of the cross-border permit for the Keystone XL pipeline and suspension of the program for oil and gas leasing on federal lands and waters.

The cost of flights, household furnishings, new cars, rental cars and clothing rose during May.


 

What should investors do?

In response to inflation, investors should:

  • Must become awareness of inflation. Inflation is likely to increase throughout the year (and perhaps further), and bonds are likely to at least be less of a stalwart than they have over the past 40 years. It is important to realize that is possible and you should all be prepared for lower near-term performance in fixed income markets.
  • Diversification is key. Equities, for example, have historically been a reasonable asset during certain inflationary periods as companies can often pass through increased costs.
  • Explore other forms of inflation protection, as well as a broader diversification of fixed income instruments.

Inflation is clearly present for U.S. consumers in the grocery stores, at gas stations and in vehicle sales. Fears over rising prices has investors fearing that pent-up demand and supply chain bottlenecks would create inflationary pressures, and force the Federal Reserve to “tamper” their monetary stimulus program and dampen demand by increasing interest rates.

References:

  1. https://www.bls.gov/news.release/cpi.nr0.htm
  2. https://blog.massmutual.com/post/markets-inflation-vanderburg
  3. https://www.schwab.com/resource-center/insights/content/is-1970s-style-inflation-coming-back
  4. https://www.schwab.com/resource-center/insights/content/schwab-market-update
  5. https://www.theguardian.com/business/2021/jun/10/us-inflation-highest-rate-stocks-consumer-price-index

Taxes Strategies in Retirement

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“Taxes in retirement will likely be lower than you expect and not all your retirement income is taxable.”

Managing taxes in retirement can be complex. Yet, thoughtful planning may help reduce the tax burden for you and your heirs. By formulating a tax-efficient investment and distribution strategy, retirees may keep more of their hard-earned assets for themselves and their heirs.

The inconvenient truth is that you’ll continue to pay taxes in retirement, which in most cases will be typically at a lower effective tax rate. And, there are a variety of reasons why your tax rate in retirement will be lower.

When you’re working, the bulk of your income is earned from your job and is fully taxable (after deductions and exemptions) at ordinary income tax rates.

When you’re retired, different tax rules can apply to each type of income you receive. You should know how each income source shows up on your tax return in order to estimate and minimize your taxes in retirement.

In retirement, only pension income, withdrawals from taxable retirement accounts such as 401(k), and any rental, business, and wage income you have is taxable at ordinary income tax rates.

Withdrawals from tax-deferred retirement accounts are taxed at ordinary income rates. These are long-term assets, but withdrawals aren’t taxed at long-term capital gains rates. IRA withdrawals, as well as withdrawals from 401(k) plans, 403(b) plans, and 457 plans, are reported on your tax return as taxable income.

Social Security is taxed at ordinary income rates, but only part of it is taxable.

You probably won’t pay any taxes in retirement if Social Security benefits are your only source of income, but a portion of your benefits will likely be taxed if you have other sources of income. The taxable amount—anywhere from zero to 85%—depends on how much other income you have in addition to Social Security.

Withdrawals from Roth accounts are tax-free if you’ve had the account for at least 5 years and are over age 59 1/2.

Accessing the principal from savings and investments is tax-free and long-term capital gains are taxed at lower rates or can even reduce other taxes if you’re selling at a loss.

You’ll pay taxes on dividends, interest income, or capital gains from investments. These types of investment income are reported on a 1099 tax form each year. Each sale of an asset will generate a long- or short-term capital gain or loss, and is reported on your tax return. Short term capital gains are taxed as ordinary income and long term gains are taxed at lower capital gains tax rate.

Tax rate: Marginal vs. Effective

Marginal tax rate is the tax rate you pay on an additional dollar of income. The reason is because the next dollar that you contribute to your retirement account would normally be taxed at the marginal tax rate.

For example, a single person with a taxable income of $50k would have a 22% marginal tax bracket for 2021. But according calculations, the effective tax rate would be 13.5% of taxable income since only taxable income over $40,525, or $9,475, would be taxed at that 22%.

When you take funds out of your 401(k) in retirement, some of your income won’t be taxed at all because of deductions and exemptions. In fact, your standard deduction would be $1,700 higher if you were age 65 or older this year.

The first $9,950 of taxable income would only be taxed at 10%. Then the next bucket of income up to $40,525 would be taxed at 12%. Only the income over $40,525 would be taxed at the 22% rate.

Ideally, you want to use the lower effective tax rate when you’re estimating how much of your retirement income will go to pay taxes.

Tax strategies

Less taxing investments

Municipal bonds, or “munis,” have long been appreciated by retirees seeking a haven from taxes and stock market volatility. In general, the interest paid on municipal bonds is exempt from federal income tax and sometimes state and local taxes as well. The higher your tax bracket, the more you may benefit from investing in munis.

Also, tax-managed mutual funds may be a consideration. Managers of these funds pursue tax efficiency by employing a number of strategies. For instance, they might limit the number of times they trade investments within a fund or sell securities at a loss to offset portfolio gains. Equity index funds may also be more tax efficient than actively managed stock funds due to a potentially lower investment turnover rate.

It’s also important to review which types of securities are held in taxable versus tax-deferred accounts. Because the maximum federal tax rate on some dividend-producing investments and long-term capital gains is 20%.

Securities to tap first

Another major decision facing retirees is when to liquidate various types of assets. The advantage of holding on to tax-deferred investments is that they compound on a before-tax basis and therefore have greater earning potential than their taxable counterparts.

On the other hand, you’ll need to consider that qualified withdrawals from tax-deferred investments are taxed at ordinary federal income tax rates of up to 37%, while distributions — in the form of capital gains or dividends — from investments in taxable accounts are taxed at a maximum 20%. Capital gains on investments held for one year or less are taxed at regular income tax rates.)

For this reason, it potentially could be beneficial to hold securities in taxable accounts long enough to qualify for the favorable long-term rate. And, when choosing between tapping capital gains versus dividends, long-term capital gains may be a consideration from an estate planning perspective because you could get a step-up in basis on appreciated assets at death.

It may also make sense to consider taking a long term view with regard to tapping tax-deferred accounts. Keep in mind, however, the deadline for taking annual required minimum distributions (RMDs).

The ins and outs of RMDs

Generally, the IRS mandates that you begin taking an annual RMD from traditional individual retirement accounts (IRAs) and employer-sponsored retirement plans after you reach age 72.

The premise behind the RMD rule is simple — the longer you are expected to live, the less the IRS requires you to withdraw (and pay taxes on) each year.

In most cases, RMDs are based on a uniform table based on the participant’s age. Failure to take the RMD can result in an additional tax equal to 50% of the difference between the required minimum distribution and the actual amount distributed during the calendar year. Tip: If you’ll be pushed into a higher tax bracket at age 72.

Estate planning and gifting

There are various ways to reduce the burden of taxes on your beneficiaries. Careful selection of beneficiaries of your retirement accounts is one example. If you do not name a beneficiary of your retirement account, the assets in the account could become distributable to your estate. Your estate or its beneficiaries may be required to take RMDs on a faster schedule (such as over five years) than what would otherwise have been required (such as ten years or over the remaining lifetime of an individual beneficiary). In most cases, naming a spouse as a beneficiary is ideal because a surviving spouse has several options that aren’t available to other beneficiaries, such as rolling over your retirement account into the spouse’s own account and taking RMDs based on the surviving spouse’s own age

Key takeaways

“Nothing in life is certain except death and taxes.” Benjamin Franklin

When it comes to investing, nothing is certain but taxes.

  • Taxation and rates varies depending on the type of retirement income you receive.
  • You may pay taxes on Social Security benefits if you have other sources of income.
  • Income from pensions, traditional IRAs, 401(k)s, and similar plans are taxed as ordinary income.
  • You’ll pay taxes on investment income, including capital gains taxes if applicable.
  • Know and calculate your effective tax rate, which in most cases, will be lower than your marginal tax rate.

 https://twitter.com/kiplinger/status/1401655591320313868

Strategies for making the most of your money and reducing taxes in retirement are complex. Plan ahead and consider meeting with a competent tax advisor, an estate attorney, and a financial professional to help you sort through your options.

References:

  1. https://www.merrilledge.com/article/tax-strategies-for-retirees
  2. https://www.fidelity.com/insights/retirement/lower-taxes-retirement
  3. https://www.thebalance.com/taxes-in-retirement-how-much-will-you-pay-2388987

Meme Stock Risks

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“There’s a problem with the memes (a stock that has gone viral online, drawing the attention of retail investors) because the people who are investing will lose a very substantial amount of money.” Thomas Peterffy

Definition:  A meme stock is a stock that has seen an increase in volume not because of the company’s performance, but rather because of hype on social media and online forums like Reddit. For this reason, these stocks often become overvalued, seeing drastic price increases in just a short amount of time.

The big problem with the so-called “meme”stock, which are assets powered higher on social-media sentiment and not on fundamentals, is that inexperienced investors will be saddled with real losses when stocks like AMC Entertainment Holdings (AMC), and GameStop Corp. (GME), eventually come back down to Earth.

The escalation in the values of these companies, like AMC and GameStop, don’t align with their prospects for earnings or revenue in the near or midterm.“There’s a problem with the “memes” because the people who are investing will lose a very substantial amount of money,” Thomas Peterffy, founder and chairman of Interactive Brokers Group Inc., said.

Peterffy said that the good thing about the surge in memes is that it will likely bring more young investor into the fold, but they will likely learn a hard lesson in the process.

Selling Short and short squeeze

Selling short means investors are betting that the asset will fall in value. The investments in AMC and GameStop originally started out as organized short-squeezes by a cadre of individual investors who had identified that a number of companies were heavily shorted by hedge funds, according to MarketWatch. These individual investors surmised, correctly, that those stocks could be pressured higher if enough buyers collectively swooped in.

A short squeeze is when many investors looking to cover short positions start buying at the same time. The buying pushes the share price higher, making short investors accelerate their attempts to cover, which sends the shares spiraling higher in a frenzy.

Short sellers, who bet a stock will fall, provide potential fuel for stock rallies when they’re wrong. If the stock jumps, instead of falling, the short sellers are forced to buy the stock to stop their losses from growing.

Lesson learned

Trying to identify a fundamental narrative that can justify meme stocks’ price and market cap are admittedly difficult. Still, it is an exercise that might provide some insights for meme stock investors. Essentially, when the music stops for the meme stocks like AMC and GameStop, investors could be looking at big capital losses.

References:

  1. https://www.thebalance.com/what-is-a-meme-stock-5118074
  2. https://www.marketwatch.com/story/interactive-brokers-founder-says-problem-with-amc-entertainment-memes-peoplewill-lose-a-very-substantial-amount-of-money-11622836260
  3. https://www.investors.com/etfs-and-funds/sectors/amc-stock-rally-here-are-the-14-most-shorted-stocks-now-sp500/
  4. https://www.marketwatch.com/articles/buy-sell-amc-stock-51622844305

Financial Planning 12 Step Process

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A financial plan creates a roadmap for your money and helps you achieve your financial goals.

The purpose of financial planning is to help you achieve short- and long-term financial goals like creating an emergency fund and achieving financial freedom, respectively. A financial plan is a customized roadmap to maximize your existing financial resources and ensures that adequate insurance and legal documents are in place to protect you and your family in case of a crisis. For example, you collect financial information and create short- and long-term priorities and goals in order to choose the most suitable investment solutions for those goals.

Although financial planning generally targets higher-net-worth clients, options also are available for economically vulnerable families. For example, the Foundation for Financial Planning connects over 15,000 volunteer planners with underserved clients to help struggling families take control of their financial lives free of charge.

Research has shown that a strong correlation exist between financial planning and wealth aggregation. People who plan their financial futures are more likely to accumulate wealth and invest in stocks or other high-return financial assets.

When you start financial planning, you usually begin with your life or financial priorities, goals or the problems you are trying to solve. Financial planning allows you to take a deep look at your financial wellbeing. It’s a bit like getting a comprehensive physical for your finances.

You will review some financial vital signs—key indicators of your financial health—and then take a careful look at key planning areas to make sure some common mistakes don’t trip you up.

Structure is the key to growth. Without a solid foundation — and a road map for the future — it’s easy to spin your wheels and float through life without making any headway. Good planning allows you to prioritize your time and measure the progress you’ve made.

That’s especially true for your finances. A financial plan is a document that helps you get a snapshot of your current financial position, helps you get a sense of where you are heading, and helps you track your monetary goals to measure your progress towards financial freedom. A good financial plan allows you to grow and improve your standing to focus on achieving your goals. As long as your plan is solid, your money can do the work for you.

A financial plan is a comprehensive roadmap of your current finances, your financial goals and the strategies you’ve established to achieve those goals. It is an ongoing process to help you make sensible decisions about money, and it starts with helping you articulate the things that are important to you. These can sometimes be aspirations or material things, but often they are about you achieving financial freedom and peace of mind.

Good financial planning should include details about your cash flow, net worth, debt, investments, insurance and any other elements of your financial life.

Financial planning is about three key things:

  • Determining where you stand financially,
  • Articulating your personal financial goals, and
  • Creating a comprehensive plan to reach those goals.
  • It’s that easy!

Creating a roadmap for your financial future is for everyone. Before you make any investing decision, sit down and take an honest look at your entire financial situation — especially if you’ve never made a financial plan before.

The first step to successful investing is figuring out your goals and risk tolerance – either on your own or with the help of a financial professional.

There is no guarantee that you’ll make money from your investments. But if you get the facts about saving and investing and follow through with an intelligent plan, you should be able to gain financial security over the years and enjoy the benefits of managing your money.

12 Steps to a DIY Financial Plan

It’s not the just the race car that wins the race; it also the driver. An individual must get one’s financial mindset correct before they can succeed and win the race. You are the root of your success. It requires:

  • Right vehicle at the right time
  • Right (general and specific) knowledge, skills and experience
  • Right you…the mindset, character and habit

Never give up…correct and continue.

Effectively, the first step to financial planning and the most important aspect of your financial life, beyond your level of income, budget and investment strategy, begins with your financial mindset and behavior. Without the right mindset around your financial well-being, no amount of planning or execution can improve your current financial situation. Whether you’re having financial difficulty, just setting goals or only mapping out a plan, getting yourself mindset right is your first crucial step.

Knowing your impulsive vices and creating a plan to reduce them in a healthy way while still rewarding yourself occasionally is a crucial part of a positive financial mindset. While you can’t control certain things like when the market takes a downward turn, you can control your mindset, behavior and the strategies you trust to make the best decisions for your future. It’s especially important to stay the course and maintain your focus on the positive outcomes of your goals in the beginning of your financial journey.

Remember that financial freedom is achieved through your own mindset and your commitment to accountability with your progress and goals.

“The first step is to know exactly what your problem, goal or desire is. If you’re not clear about this, then write it down, and then rewrite it until the words express precisely what you are after.” W. Clement Stone

1. Write down your goals—In order to find success, you first have to define what that looks like for you. Many great achievements begin as far-off goals, that seem impossible until it’s done. Though you may not absolutely need a goal to succeed, research still shows that those who set goals are 10 times more successful than those without goals. By setting SMART financial goals (specific, measurable, achievable, relevant, and time-bound), you can put your money to work towards your future. Think about what you ultimately want to do with your money — do you want to pay off loans? What about buying a rental property? Or are you aiming to retire before 50? So that’s the first thing you should ask yourself. What are your short-term needs? What do you want to accomplish in the next 5 to 10 years? What are you saving for long term? It’s easy to talk about goals in general, but get really specific and write them down. Which goals are most important to you? Identifying and prioritizing your values and goals will act as a motivator as you dig into your financial details. Setting concrete goals may keep you motivated and accountable, so you spend less money and stick to your budget. Reminding yourself of your monetary goals may help you make smarter short-term decisions about spending and help to invest in your long-term goals. When you understand how your goal relates to what you truly value, you can use these values to strengthen your motivation. Standford Psychologist Kelly McGonigal recommends these questions to get connected with your ideal self:

  • What do you want to experience more of in your life, and what could you do to invite that/create that?
  • How do you want to be in the most important relationships or roles in your life? What would that look like, in practice?
  • What do you want to offer the world? Where can you begin?
  • How do you want to grow in the next year?
  • Where would you like to be in ten years?

Writing your goals out means you’ll be anywhere from 1.2 to 1.4 times more likely to fulfill them. Experts theorize this is because writing your goals down helps you to choose more specific goals, imagine and anticipate hurdles, and helps cement them in your mind.

2. Create a net worth statement—To create a successful plan, you first need to understand where you’re starting so you can candidly address any weak points and create specific goals. First, make a list of all your assets—things like bank and investment accounts, real estate and valuable personal property. Now make a list of all your debts: mortgage, credit cards, student loans—everything. Subtract your liabilities from your assets and you have your net worth. Your ratio of assets to liabilities may change over time — especially if you pay off debt and put money into savings accounts. Generally, a positive net worth (your assets being greater than your liabilities) is a monetary health signal. If you’re in the plus, great. If you’re in the minus, that’s not at all uncommon for those just starting out, but it does point out that you have some work to do. But whatever it is, you can use this number as a benchmark against which you can measure your progress.

3. Review your cash flow—Cash flow simply means money in (your income) and money out (your expenses). How much money do you earn each month? Be sure to include all sources of income. Now look at what you spend each month, including any expenses that may only come up once or twice a year. Do you consistently overspend? How much are you saving? Do you often have extra cash you could direct toward your goals?

4. Zero in on your budget—Your cash-flow analysis will let you know what you’re spending. Zeroing in on your budget will let you know how you’re spending. Write down your essential expenses such as mortgage, insurance, food, transportation, utilities and loan payments. Don’t forget irregular and periodic big-ticket items such as vehicle repair or replacement costs, out of pocket health care costs and real estate taxes. Then write down nonessentials—restaurants, entertainment, even clothes. Does your income easily cover all of this? Are savings a part of your monthly budget? Examining your expenses and spending helps you plan and budget when you’re building an emergency fund. It will also help you determine if what you’re spending money on aligns with your values and what is most important to you.  An excellent method of budgeting is the 50/30/20 rule. To use this rule, you divide your after-tax income into three categories:

  • Essentials (50 percent)
  • Wants (30 percent)
  • Savings (20 percent)

The 50/30/20 rule is a great and simple way to achieve your financial goals. With this rule, you can incorporate your goals into your budget to stay on track for monetary success.

5. Create an Emergency Fund–Did you know that four in 10 adults wouldn’t be able to cover an unexpected $400 expense, according to U.S. Federal Reserve? With so many people living paycheck to paycheck without any savings, unexpected expenses might seriously throw off someone’s life if they aren’t prepared for the emergency. It’s important to save money during the good times to account for the bad ones. This rings especially true these days, where so many people are facing unexpected monetary challenges. Keep 12 months of essential expenses as Emergency Fund or a rainy day fund.  If you or your family members have a medical history, you may add 5%-10% extra for medical emergencies (taking cognizance of the health insurance cover) to the amount calculated using the above formula. An Emergency Fund is a must for any household. Park the amount set aside for contingencies in a separate saving bank account, term deposit, and/or a Liquid Fund.

6. Focus on debt management—Debt can derail you, but not all debt is bad. Some debt, like a mortgage, can work in your favor provided that you’re not overextended. It’s high-interest consumer debt like credit cards that you want to avoid. Don’t go overboard when taking out a home loan. It can be frustrating to allocate your hard-earned money towards savings and paying off debt, but prioritizing these payments can set you up for success in the long run. But, as a rule of thumb, the value of the house should not exceed 2 or 3 times your family’s annual income when buying on a home loan and the price of your car should not exceed 50% of annual income. Try to follow the 28/36 guideline suggesting no more than 28 percent of pre-tax income goes toward home debt, no more than 36 percent toward all debt. This is called the debt-to-income ratio. If you stick to this ratio, it will be easier to service your loans/debt. Borrow only as much as you can comfortably repay. If you have multiple loans, it is advisable to consolidate all loans into a single loan, that has the lowest interest rate and repay it regularly.

“Before you pay the government, before you pay taxes, before you pay your bills, before you pay anyone, the first person that gets paid is you.” David Bach

7. Get your retirement savings on track—Whatever your age, retirement planning is an essential financial goal and retirement saving needs to be part of your financial plan. Although retirement may feel a world away, planning for it now is the difference between a prosperous retirement income and just scraping by. The earlier you start, the less you’ll likely have to save each year. You might be surprised by just how much you’ll need—especially when you factor in healthcare costs. To build a retirement nest egg, aim to create at least 20 times your Gross Total Income at the time of your retirement. This is necessary to keep up with inflation. But if you begin saving early, you may be surprised to find that even a little bit over time can make a big difference thanks to the power of compounding interest. Do not ignore ‘Rule of 72’ – As per this rule, the number 72 is divided by the annual rate of return on investment to determine the time it may take to double the money invested. There are several types of retirement savings, the most common being an IRA, a Roth IRA, and a 401(k):

  • IRA: An IRA is an individual retirement account that you personally open and fund with no tie to an employer. The money you put into this type of retirement account is tax-deductible. It’s important to note that this is tax-deferred, meaning you will be taxed at the time of withdrawal.
  • Roth IRA: A Roth IRA is also an individual retirement account opened and funded by you. However, with a Roth IRA, you are taxed on the money you put in now — meaning that you won’t be taxed at the time of withdrawal.
  • 401(k): A 401(k) is a retirement account offered by a company to its employees. Depending on your employer, with a 401(k), you can choose to make pre-tax or post-tax (Roth 401(k)) contributions. Calculate how much you will need and contribute to a 401(k) or other employer-sponsored plan (at least enough to capture an employer match) or an IRA.

Ideally, you should save 15% to 30% from your net take-home pay each month, before you pay for your expenses. This money should be invested in assets such as stocks, bonds and real estate to fulfil your envisioned financial goals. If you cannot save 15% to 30%, save what you can and gradually try and increase your savings rate as your earnings increase. Whatever you do, don’t put it off.

After retiring, follow the ‘80% of the income rule’. As per this rule, from your investments and/or any other income-generating activity, you need to generate at least 80% of the income you had while working. This will ensure that you can take care of your post-retirement expenses and maintain a comfortable standard of living. So make sure to invest in productive assets.

8. Check in with your portfolio—If you’re an investor, when was the last time you took a close look at your portfolio? If you’re not an investor, To start investing, you should first figure out the initial amount you want to deposit. No matter if you invest $50 or $5,000, putting your money into investments now is a great way to plan for financial success later on. Market ups and downs can have a real effect on the relative percentage of stocks and bonds you own—even when you do nothing. And even an up market can throw your portfolio out of alignment with your feelings about risk. Don’t be complacent. Review and rebalance on at least an annual basis. As a rule of thumb, your equity allocation should be 100 minus your current age – Many factors determine asset allocation, such as age, income, risk profile, nature and time horizon for your goals, etc. But you could broadly follow the formula: 100 minus your current age as the ratio to invest in equity, with the rest going to debt. And, never invest in assets you do not understand well.

  • Good health is your greatest need. Without good health, you can’t enjoy anything else in life.

9. Make sure you have the right insurance—As your wealth grows over time, you should start thinking about ways to protect it in case of an emergency. Although insurance may not be as exciting as investing, it’s just as important. Insuring your assets is more of a defensive financial move than an offensive one. Having adequate insurance is an important part of protecting your finances. We all need health insurance, and most of us also need car and homeowner’s or renter’s insurance. While you’re working, disability insurance helps protect your future earnings and ability to save. You might also want a supplemental umbrella policy based on your occupation and net worth. Finally, you should consider life insurance, especially if you have dependents. Have 10 to 15 times of annual income as life insurance – If you are the bread earner of your family, you should have a tem life insurance coverage of around 10 to 15 times your annual income and outstanding liabilities. No compromise should be made in this regard. Review your policies to make sure you have the right type and amount of coverage. Here are some of the most important ones to get when planning for your financial future.

  • Life insurance: Life insurance goes hand in hand with estate planning to provide your beneficiaries with the necessary funds after your passing.
  • Homeowners insurance: As a homeowner, it’s crucial to protect your home against disasters or crime. Many people’s homes are the most valuable asset they own, so it makes sense to pay a premium to ensure it is protected.
  • Health insurance: Health insurance is protection for your most important asset: Your health and life. Health insurance covers your medical expenses for you to get the care you need.
  • Auto insurance: Auto insurance protects you from costs incurred due to theft or damage to your car.
  • Disability insurance: Disability insurance is a reimbursement of lost income due to an injury or illness that prevented you from working.

10. Know your income tax situation—Taxes can be a drag, but understanding how they work can make all the difference for your long-term financial goals. While taxes are a given, you might be able to reduce the burden by being efficient with your tax planning. Tax legislation tend to change a number of deductions, credits and tax rates. Don’t be caught by surprise when you file your last year’s taxes. To make sure you’re prepared for the tax season, review your withholding, estimated taxes and any tax credits you may have qualified for in the past. The IRS has provided tips and information at https://www.irs.gov/tax-reform. Taking advantage of tax sheltered accounts like IRAs and 401(k)s can help you save money on taxes. You may also want to check in with your tax accountant for specific tax advice.

11. Create or update your estate plan—Thinking about estate planning is important to outline what happens to your assets when you’re gone. To create an estate plan, you should list your assets, write your will, and determine who will have access to the information. At the minimum, have a will—especially to name a guardian for minor children. Also check that beneficiaries on your retirement accounts and insurance policies are up-to-date. Complete an advance healthcare directive and assign powers of attorney for both finances and healthcare. Medical directive forms are sometimes available online or from your doctor or hospital. Working with an estate planning attorney is recommended to help you plan for complex situations and if you need more help.

12. Review Your Plans Regularly–Figuring out how to create a financial plan isn’t a one-time thing. Your goals (and your financial standing) aren’t stagnant, so your plan shouldn’t be either. It’s essential to reevaluate your plan periodically and adjust your goals to continue setting yourself up for success. As you progress in your career, you may want to take a more aggressive approach to your retirement plan or insurance. For example, a young 20-something in their first few years of work likely has less money to put into their retirement and savings accounts than a person in their mid-30s who has an established career. Staying updated with your financial plan also ensures that you hold yourself accountable to your goals. Over time, it may become easy to skip one payment here or there, but having concrete metrics might give you the push you need for achieving a future of financial literacy. After you figure out how to create a monetary plan, it’s good practice to review it around once a year.

Additionally, take into account factors such as the following:

  • The number of years left before you retire
  • Your life expectancy (an estimate, based on your family’s medical history)
  • Your current basic monthly expenditure
  • Your existing assets and liabilities
  • Contingency reserve, if any
  • Your risk appetite
  • Whether you have adequate health insurance
  • Whether you have provided for other life goals
  • Inflation growth rate

A financial plan isn’t a static document to sit on — it’s a tool to manage your money, track your progress, and one you should adjust as your life evolves. It’s helpful to reevaluate your financial plan after major life milestones, like getting m arried, starting a new job or retiring, having a child or losing a loved one.

Financial planning is a great strategy for everyone — whether you’re a budding millionaire or still in college, creating a plan now can help you get ahead in the long run, especially if you want to make a roadmap to a successful future.

For additional financial planning resources to create your own financial plan, go to the MoneySense complete financial plan kit.

References:

  1. https://www.pewtrusts.org/en/research-and-analysis/articles/2017/04/06/can-economically-vulnerable-americans-benefit-from-financial-capability-services
  2. https://www.forbes.com/sites/forbesfinancecouncil/2020/05/26/your-mindset-is-everything-when-it-comes-to-your-finances/?sh=22f5cb394818
  3. https://www.schwab.com/resource-center/insights/content/10-steps-to-diy-financial-plan
  4. https://www.principal.com/individuals/build-your-knowledge/build-your-own-financial-plan-step-step-Guide
  5. https://mint.intuit.com/blog/planning/how-to-make-a-financial-plan/
  6. https://www.federalreserve.gov/publications/files/2017-report-economic-well-being-us-households-201805.pdf
  7. https://news.stanford.edu/news/2015/january/resolutions-succeed-mcgonigal-010615.html
  8. https://www.investec.com/content/dam/united-kingdom/downloads-and-documents/wealth-investment/for-myself/brochures/financial-planning-explained-investec-wealth-investment.pdf
  9. https://www.sec.gov/investor/pubs/tenthingstoconsider.html
  10. https://www.nerdwallet.com/article/investing/what-is-a-financial-plan
  11. https://www.axisbank.com/progress-with-us/money-matters/save-invest/10-rules-of-thumb-for-financial-planning-and-wellbeing
  12. https://twocents.lifehacker.com/10-good-financial-rules-of-thumb-1668183707

 

Stimulus, Inflation, Unsustainable Debt and America | Fidelity Investments and Peterson Foundation

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“America has been on an unsustainable fiscal path for many years, since long before this pandemic.” The Peter G. Peterson Foundation

  • The new $1.9 trillion stimulus spending package, on top of trillions already spent to revive the economy, is driving the national debt to unprecedented levels.
  • History shows that high government debt often leads to inflation, and an uptick in inflation is expected this year as the economy recovers.

The $1.9 trillion federal stimulus package will help many families, businesses, and state and local governments hard hit by the pandemic. But it is also fueling concerns about the ballooning federal debt, inflation, and how investors can protect themselves.

The Congressional Budget Office projected that the federal budget deficit will rise during the second half of the decade and climb steadily over the following 20 years.  By 2051, the federal debt is expected to double as a share of the economy.

The projections by the nonpartisan office forecast a more challenging long-term outlook, as interest costs on the national debt rise and federal spending on health programs swells along with an aging population.  “A growing debt burden could increase the risk of a fiscal crisis and higher inflation as well as undermine confidence in the U.S. dollar, making it more costly to finance public and private activity in international markets,” the CBO report said.

Our federal fiscal budget has structural problems, driven by well-known and predictable factors that include an aging population, rising healthcare costs and compounding interest—along with insufficient revenues to meet our commitments, according to The Peter G. Peterson Foundation.

Over the last 20 years, the federal government’s debt has grown faster than at any time since the end of World War II, running well ahead of economic growth. In addition to COVID-related spending, rising federal debt has been driven by longer-term trends including increasing Social Security and Medicare spending for an aging population. Today, according to the Congressional Budget Office, the federal debt is $22.5 trillion, more than 100% of gross domestic product (GDP).

Why debt matters

New Fidelity research suggests that higher debt can slow economic growth, and ultimately lead to higher inflation and more volatile financial markets. Warns Dirk Hofschire, senior vice president of asset allocation research at Fidelity Investments: “Debt in the world’s largest economies is fast becoming the most substantial risk in investing today.”

In the short term, Fidelity’s director of global macro Jurrien Timmer says a market consensus has emerged that inflation will rise in the second half of 2021: “An inflationary boom could result from the combination of COVID infections falling, vaccinations rising, ongoing massive fiscal stimulus, pent-up consumer demand, and low interest rates.”

FEDERAL DEBT IS ON AN UNSUSTAINABLE PATH

Longer term, Hofschire says, “The rise in debt is unsustainable. Historically, no country has perpetually increased its debt/GDP ratio. The highest levels of debt all topped out around 250% of GDP. Since 1900, 18 countries have hit a debt/GDP level of 100%, generally due to the need to pay for fighting world wars or extreme economic downturns such as the Great Depression. After hitting the 100% threshold, 10 countries reduced their debt, 7 increased it, and one kept its level of debt roughly the same.”

Only time will tell which way the US goes and when. But Hofschire thinks “government policies are likely to drift toward more inflationary options.” Among them:

  • Federal spending aimed at lower- and middle-income consumers
  • Increased public works spending not offset by higher taxes
  • Protectionist measures with a “made in America” rationale
  • Infrastructure upgrades targeting sectors such as renewable energy, 5G telecom, and health care
  • Higher inflation targeting by the Federal Reserve
  • Mandatory pay increases for workers benefiting from government assistance

In the longer term, if further free-spending fiscal policies are adopted while interest rates stay low and credit remains abundant, the likelihood of inflation could increase. But history suggests the magnitude and timing is uncertain. Many predicted an inflation surge the last time the federal government embarked on major fiscal and monetary stimulus after the global financial crisis, but inflation mostly failed to appear.

THE GROWING DEBT IS CAUSED BY A STRUCTURAL MISMATCH BETWEEN SPENDING AND REVENUES according to The Peterson Foundation

Why the national debt matters, according the The Peter G. Peterson Foundation:

  • High and rising federal debt matters because it reduces the county’s flexibility to plan for and respond to urgent crises.
  • Debt matters because growing interest costs make it harder to invest in our future — to build and sustain infrastructure, enhance education and support an economy that creates job growth and rising wages.
  • Debt matters because it threatens the safety net — critical programs like Social Security, Medicaid, Medicare, SNAP and Unemployment Compensation are essential lifelines for the most vulnerable populations.
  • Debt matters because America faces emerging and ongoing challenges that will require fiscal resources to keep the country safe, secure and strong — challenges like socioeconomic injustice, climate change, affordable health care, wealth and income inequality, international conflicts and an increasingly complex and competitive global economy.
  • Debt matters because the nation should care about its children and grandchildren. Borrowing more and more today reduces the opportunities and prosperity of the next generation.

The U.S. faces a range of complex, unprecedented health, economic and societal challenges, set against the backdrop of a poor fiscal outlook that was irresponsible and unsustainable before the crisis.

Building a brighter future for the next generation must become an essential priority for America, and the high cost of this health and economic crisis only makes that challenge more urgent. Once America has emerged from the pandemic, it will be more important than ever for its elected leaders to address the unsustainable fiscal outlook and manage the burgeoning national debt, to ensure that America is more prepared, better positioned for growth, and able to meet its moral obligation to future generations.

References:

  1. https://www.cbo.gov/publication/57038
  2. https://www.fidelity.com/learning-center/personal-finance/government-spending-2021?ccsource=email_weekly
  3. https://www.pgpf.org/what-does-the-national-debt-mean-for-americas-future

* The Peter G. Peterson Foundation is a non-profit, non-partisan organization that is dedicated to increasing public awareness of the nature and urgency of key fiscal challenges threatening America’s future, and to accelerating action on them. To address these challenges successfully, we work to bring Americans together to find and implement sensible, long-term solutions that transcend age, party lines and ideological divides in order to achieve real results.

Tax on the Sale of a House (Primary Residence)

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If you sell your home for a profit, some of the capital gain could be taxable. Capital gains are the profits from the sale of an asset — shares of stock, a piece of land, a business — and generally are considered taxable income.

The IRS and many states assess capital gains taxes on the difference (profit) between what you pay for an asset — your cost basis — and what you sell it for. Capital gains taxes can apply to investments, such as stocks or bonds, and tangible assets like cars, boats and real estate.

To minimize your tax burden, the IRS typically allows you to exclude up to:

  • $250,000 of capital gains on your primary residence if you’re single.
  • $500,000 of capital gains on real estate if you’re married and filing jointly.

You will have to meet certain criteria in order to qualify for this exclusion, so be sure to review them before you sell. You might qualify for an exception, and adding the value of home improvements you’ve made could help.

For example, if you bought a home 10 years ago for $200,000 and sold it today for $800,000, you’d make $600,000. If you’re married and filing jointly, $500,000 of that gain might not be subject to the capital gains tax (but $100,000 of the gain could be), according to NerdWallet.com. What rate you pay on the other $100,000 would depend in part on your income and your tax-filing status.

The bad news about capital gains on real estate is that your $250,000 or $500,000 exclusion typically goes out the window, which means you pay tax on the whole gain, if any of these factors are true:

  • The house wasn’t your principal residence.
  • You owned the property for less than two years in the five-year period before you sold it.
  • You didn’t live in the house for at least two years in the five-year period before you sold it. (People who are disabled, and people in the military, Foreign Service or intelligence community can get a break on this part, though; see IRS Publication 523 for details.)
  • You already claimed the $250,000 or $500,000 exclusion on another home in the two-year period before the sale of this home.
  • You bought the house through a like-kind exchange (basically swapping one investment property for another, also known as a 1031 exchange) in the past five years.
  • You are subject to expatriate tax.

If it turns out that all or part of the money you made on the sale of your house is taxable, you need to figure out what capital gains tax rate applies.

  • Short-term capital gains tax rates typically apply if you owned the asset for less than a year. The rate is equal to your ordinary income tax rate, also known as your tax bracket.
  • Long-term capital gains tax rates typically apply if you owned the asset for more than a year. The rates are much less onerous; many people qualify for a 0% tax rate. Everybody else pays either 15% or 20%. It depends on your filing status and income.

References:

  1. https://www.nerdwallet.com/article/taxes/selling-home-capital-gains-tax

Federal Debt has Surpassed the Size of the U.S. Economy | New York Times

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By Matt Phillips. Aug. 21, 2020 Updated 7:48 a.m. ET

The national debt of the United States now exceeds the size of the nation’s gross domestic product. That was once considered by economists a doomsday scenario that would wreck the U.S. economy. So far, that hasn’t happened.

“Economists and deficit hawks have warned for decades that the United States was borrowing too much money. The federal debt was ballooning so fast, they said, that economic ruin was inevitable: Interest rates would skyrocket, taxes would rise and inflation would probably run wild.”

“The death spiral could be triggered once the debt surpassed the size of the U.S. economy — a turning point that was probably still years in the future.”

“It actually happened much sooner: sometime before the end of June 2020.”

“”This is a 40-year pattern,” said Stephanie Kelton, a professor of economics and public policy at Stony Brook University and a proponent of what’s often called Modern Monetary Theory. That view holds that countries that control their own currencies have far more leeway to run large deficits than traditionally thought. “The whole premise that deficits drive up interest rates, it’s just wrong,” she said.”

“At the end of last year, the United States was about $17 trillion in debt — roughly 80 percent of the gross domestic product. In January, government analysts predicted that debt would approach 100 percent of the G.D.P. around 2030. But by the end of June, the debt stood at $20.63 trillion, or roughly 106 percent of G.D.P., which shrank amid widespread stay-at-home orders. (These numbers don’t count trillions more the government owes itself in bonds held by the Social Security and Medicare trust funds.)”

“Economists have long told a story in which debt levels this large inevitably ignited an economic doom loop. Towering levels of debt would freak out Treasury bond investors, who would demand higher interest rates to hand their cash to such a heavily indebted borrower. With its debt payments more expensive, the government would have to borrow even more to stay current on its obligations.”

“Neither tax increases nor spending cuts would be attractive, because both could slow the economy — and any slowdown would hurt tax revenues, meaning the government would have to keep borrowing more. These scenarios frequently included dire predictions of soaring interest rates for business and consumer borrowing and crushing inflation as the government printed more and more money to pay what it owed.”

“But instead of panicking, the financial markets are viewing this seemingly bottomless need for borrowing benignly. The interest rate on the 10-year Treasury note — also known as its yield — is roughly 0.7 percent, far below where it was a little over a year ago, when it was about 2 percent.”

“There’s a debate about whether a large amount of government debt hamstrings economic growth over the long term. Some influential studies have shown that high levels of debt — in particular debt-to-G.D.P. ratios approaching 100 percent — are associated with lower levels of economic growth. But other researchers have found that the relationship isn’t causal: Slowing economic growth might lead to higher levels of debt, rather than vice versa.”

“Others have found that they don’t see much of a relationship between high levels of debt and slow economic growth for rich developed countries.”

“The experience over the last decade has drastically shifted the way economists and investors think about how the United States funds itself.”

Read more: https://www.nytimes.com/2020/08/21/business/economy/national-debt-coronavirus-stimulus.html?referringSource=articleShare

Income tax rates have increased relative to estate tax rates

Aside

Changes in the federal tax law make it increasingly important to focus on the income tax consequences of estate planning in addition to the estate tax consequences. For estates still subject to federal estate tax, the federal estate tax rate is 40%. These rates must be compared with the top federal income tax rates of 37% on ordinary income and 20% on long-term capital gains and qualified dividends, plus a 3.8% Medicare net investment income tax.

Furthermore, trust income tax rates must be taken into consideration. Trusts are taxed at the highest federal income tax bracket starting at $12,950 in annual trust income. Therefore, when transferring assets to a trust for estate planning purposes, consideration should be given to the potentially negative consequences of higher income taxes. Outdated estate plans may not provide the flexibility required to shift the income tax burden from the trust to individuals in potentially lower tax brackets.

Revisit your estate planning documents and gifting strategies with your attorney and tax professional to determine whether they are still appropriate, considering the Medicare net investment income tax, the current federal estate tax rate, and the increased applicable exclusion amount.

Estate Planning

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“I want to leave my children enough that they feel they can do anything, but not so much that they do nothing.” ~ Warren Buffet

Your Estate Plan

Although estate planning can be a complex task, a well-informed plan can make a big difference in what is left for your loved ones.

Source: Fidelity Investment

Here are a few steps you can take to begin thinking about your estate plan:

  • Gather important documents, and make sure that key family members know where they are.
  • Gather a list of all the things you own, noting any liabilities (like your mortgage) as well. Record the value of each asset (properties, collectibles, jewelry, etc.). Print copies of your most recent statements from your relevant accounts. Note the values and benefits from insurance policies.
  • Consider and write down your objectives for your estate plan. Who should get which assets? Who should get them if something should happen to your beneficiaries? Do you have minors who need care if something were to happen right now? Who should handle your assets if you become unable to make decisions about them? And so forth.
  • Review your will, if you have one in place.
  • Review and update the beneficiaries of your retirement accounts or insurance policies.
  • Review and update powers of attorney for matters of health care or other affairs.
  • Consider if you want to establish a trust, and prepare to talk to an attorney and experienced financial adviser about it.

We never know what could happen tomorrow. But we do know that having a solid estate plan can help ease the burden of your passing on your loved ones.

Revocable vs. Irrevocable Trusts

A trust is a fiduciary arrangement that allows a third party, or trustee, to hold assets on behalf of a beneficiary or beneficiaries. Trusts can be arranged in many ways and can specify exactly how and when the assets pass to the beneficiaries.

Since trusts usually avoid probate, your beneficiaries may gain access to these assets more quickly than they might to assets that are transferred using a will. Additionally, if it is an irrevocable trust, it may not be considered part of the taxable estate, so fewer taxes may be due upon your death.

Assets in a trust may also be able to pass outside of probate, saving time, court fees, and potentially reducing estate taxes as well.

Other benefits of trusts include:

  • Control of your wealth. You can specify the terms of a trust precisely, controlling when and to whom distributions may be made. You may also, for example, set up a revocable trust so that the trust assets remain accessible to you during your lifetime while designating to whom the remaining assets will pass thereafter, even when there are complex situations such as children from more than one marriage.
  • Protection of your legacy. A properly constructed trust can help protect your estate from your heirs’ creditors or from beneficiaries who may not be adept at money management.
  • Privacy and probate savings. Probate is a matter of public record; a trust may allow assets to pass outside of probate and remain private, in addition to possibly reducing the amount lost to court fees and taxes in the process.Trusts are a powerful and beneficial tool when properly used.

There are two types of trusts: a revocable living trust and an irrevocable trust. Some other terms associated with trusts include “grantor” and “non-grantor” — which are the parties creating the trust.

With a revocable living trust, you still control the assets, can change the trustee at any time, or sell your assets while you’re living, because the grantor — the person who created the trust — is normally the trustee as well. The only benefit a revocable living trust provides is to ensure your assets bypass probate. It does not provide any immediate tax benefits. In fact, income from a revocable living trust is taxed to the grantor.

An irrevocable trust is completely different. It can be used when “gifting” assets in order to reduce a grantor’s taxable estate. Be aware that once you transfer assets to an irrevocable trust, changes are permanent and cannot be undone — or at best — can only be made through a lengthy process. You no longer have any control to sell investments inside the trust and will have to ask your trustee — typically your children or grandchildren — to do so. Since you don’t legally own the assets any longer, they’re either taxed at trust income tax rates or your beneficiaries’ tax rates.

By using a will or trust to legally ensure that you will not only protect the things you worked hard to achieve, you will have the final say about those assets — taking care of the people you love when you’re no longer here. That means not leaving such decisions to attorneys, state governments or the IRS.

References:

  1. https://www.kiplinger.com/article/retirement/T021-C032-S014-estate-planning-is-more-important-than-you-think.html
  2. https://www.fidelity.com/life-events/estate-planning/basics
  3. https://www.fidelity.com/life-events/estate-planning/trusts