Still River Financial Planning

How The Gift Tax Works

amyfunahahsi — Fri, 30 Sep 2022 20:15:00 +0000

When you give gifts to anyone other than a spouse, gift tax rules may apply. But this rarely results in needing to pay any taxes. Here’s what is required by the rules, and how they might apply to you.

The Yearly Gift Tax Exclusion

For 2022, you can give gifts up to $16,000 per person with absolutely no tax consequences. This means you could give $16,000 each year to each of your children or grandchildren and never pay any tax or be required to file a gift tax return. This annual exclusion amount is occasionally adjusted for inflation.

If you exceed $16,000 in gifts to a single person, you need to file a gift tax return with the IRS for that year.

How the Gift Tax and Estate Tax Work Together

Filing a gift tax return does not necessarily mean that you pay any gift tax. Any gifts over $16,000 simply reduce your lifetime gift and estate tax exemption.

This lifetime exemption is currently $12.06 million for each individual. And it means that if you pass away with assets valued at greater than $12.06 million, you would owe estate taxes on the amount above the exemption.

Let’s take a look at a couple examples:

Let’s say you pass away with $12.5 million worth of assets and did not give any gifts that were over the annual exclusion throughout your lifetime. This means you would owe estate taxes on $440,000 – the difference between your total assets and the lifetime exemption.
Now let’s say you pass away with $11.5 million of assets, but in the year before you died, you gifted your child $1,016,000. Since this amount exceeds the $16,000 annual exclusion, your lifetime exemption is reduced by $1,000,000. Your lifetime exemption is now $11.06 million, and you still owe estate taxes on $440,000 at the time of your death.

How the Gift Tax Impacts Young Families

There are a couple scenarios for young families to be aware of when thinking about gift tax rules.

Any contributions to a custodial/UTMA account or a 529 college savings account are considered gifts to the child who either owns the custodial account or who is the beneficiary of the 529 account. So any contributions over $16,000 will reduce your lifetime exemption, and you need to file a gift tax return.

One exception to this rule is the ability to “superfund” a 529 plan. The IRS allows you to contribute a lump sum of up to 5 times the annual exclusion (currently $80,000) to a 529 plan in a single year. The gift is considered as having been made evenly over 5 years and does not reduce your lifetime exemption. But if you do contribute the full $80,000 allowed, you cannot make any additional gifts to that child until the 5 year period has ended.

The last consideration to be aware of is that tuition paid directly to an educational institution on a child’s behalf is not considered a gift. This applies only to tuition and not room and board, books, or supplies.

Conclusion

As you can see, for most people the gift tax rules never result in any actual tax being paid. But it is important to be aware of the annual exclusion limits so that you can properly report any gifts that will reduce your lifetime exemption.

Joe Calvetti is a CPA and the founder of Still River Financial Planning, a comprehensive, fee-only financial planning firm that specializes in working with young families and professionals. Click here to learn more about how we work with clients.

Are you interested in staying up to date on new articles and other news from us? Sign up for our newsletter or follow us on Facebook and Instagram.

Ready to learn more about how we can work together? Schedule an introductory call.

Disclaimer: The information provided above is for educational purposes only and should not be considered financial, legal, or tax advice. You should consult with a professional for advice specific to your situation.

The post How The Gift Tax Works appeared first on Still River Financial Planning.

How Traditional Financial Planning Has Failed Young Families

amyfunahahsi — Fri, 19 Aug 2022 20:11:00 +0000

Financial planning has historically been almost inaccessible to young families.
And this primarily comes down to the way financial planners have charged for their services.

How it has worked in the past

Assets Under Management

The assets under management (AUM) fee model makes a lot of sense for retirees or those on the verge of retirement. The advisor charges a percentage of the assets that they directly manage for the client. And many advisors also require a minimum amount of assets.

Not a problem for someone who has built up a significant nest egg.

But this model doesn’t work well for young families who are either still working to build up a significant amount of assets or have much of their wealth in an employer sponsored plan like a 401(k) which cannot be managed directly by an advisor.

Commissions

The other approach taken by some financial advisors is to work on a commission basis. This involves selling products like permanent life insurance, annuities, or actively managed mutual funds.

This type of relationship may seem more affordable because commissions are not coming out of your pocket. But the problem is the vast majority of young families have no need for any of the products being sold to them. This creates some significant conflict of interest between the advisor and the family they are working with, which is not ideal.

How things are changing

Luckily, the financial advice industry has recognized these issues and there are new and more creative ways for financial planners to work with young families. Here is how we do it:

We operate on a fee-only basis and don’t require any minimum level of assets.
We don’t require you to move any of your money under our control – you keep your accounts wherever you’d like (we will of course make recommendations for you and help you execute those).
For ongoing planning, we charge a monthly subscription fee that is based on income and net worth – which aims to tie any future fee increases to changes in the complexity of your financial life.
We are transparent about exactly what that fee will be – see the details here.

Our goal is to make financial planning more accessible to young families – at a time in your life when adjustments you make can not only impact your current situation, but also have a big and compounding impact on your long term goals.

If you have questions about how we operate, get in touch with us here.

Are you interested in staying up to date on new articles and other news from us? Sign up for our newsletter or follow us on Facebook and Instagram.

Ready to learn more about how we can work together? Schedule an introductory call.

The post How Traditional Financial Planning Has Failed Young Families appeared first on Still River Financial Planning.

Why You Need Life and Long Term Disability Insurance

amyfunahahsi — Fri, 12 Aug 2022 20:10:00 +0000

If you have someone depending on your income, life and long term disability insurance are a must.

Long Term Disability Insurance

If you don’t already have long term disability insurance through your employer, you should look into buying coverage. Statistics show you are more likely to become disabled during your working career than to die early. And disability insurance is designed to replace your income if you’re unable to work for an extended period.

Disability insurance not only provides some peace of mind for anyone who relies on your income, but it also allows you to leave your emergency fund and long term investments untouched if you were unable to work for a period of time.

You may have the option to pay the premium yourself versus having your employer cover the cost of the insurance. It might seem like an additional benefit to have your employer pay, but if you pay the premiums instead, any benefit you receive will be tax free.

Life Insurance

Term or Permanent?

Term life insurance is typically sufficient for most families. This allows you to pay for coverage only when you need it most – while you have kids living at home and before you have saved enough to no longer be reliant on your income.

Permanent life insurance is significantly more expensive than term insurance. So make sure you have good reason for it before jumping in.

Having a child with disabilities who will need support even after you pass away could be a good reason for going this route. And for some families that will face significant estate tax bills, permanent insurance can be a useful planning tool.

Be sure to think about what your true need is, and when that need ends (if at all) before making this decision.

How Much Do You Need?

To determine how much coverage you need, first think about whether your current income is covering your living expenses and your savings toward your long term goals. If yes, multiply your yearly take home pay (there is no need to use gross pay because life insurance proceeds are not taxable) by the number of years you have until retirement. This will give you a rough idea of how much coverage you may want.

You can think about laddering life insurance policies, which means instead of buying one 30 year term policy, you might buy three policies with 10 year, 20 year, and 30 year terms. Each policy would be ⅓ of the total value you want to insure.

This will save money on the premiums you pay (since a 10 year policy is cheaper than a 30 year policy). And it will also reduce the amount of insurance you have over time as you build up your savings and become less reliant on your income.

Final Thoughts

Life insurance and long term disability insurance are safety nets for those who depend on your income. No one likes to think about needing them, but they’re critical tools for ensuring your family is financially secure even if you’re not able to support them.

Are you interested in staying up to date on new articles and other news from us? Sign up for our newsletter or follow us on Facebook and Instagram.

Ready to learn more about how we can work together? Schedule an introductory call.

The post Why You Need Life and Long Term Disability Insurance appeared first on Still River Financial Planning.

5 Reasons Young Families Need a Financial Plan

amyfunahahsi — Fri, 05 Aug 2022 20:07:00 +0000

As a young family, you probably know that it would be beneficial to get your finances in order and plan for the future, but life often gets in the way.

Or you may think retirement is so far off that you have plenty of time to get around to figuring it out.

Below are some of the reasons young families could benefit from creating a financial plan.

1. You have a lot of competing priorities

Young families typically have a lot of financial goals – saving for retirement, deciding on how and when to be saving for college, taking vacations, buying life insurance (not that exciting, I know – but important!).

Putting together a financial plan can help you get these priorities in order. It can also give you some confidence that you are taking the right steps to be able to do the things you want to do.

2. You’re making decisions with long term impacts

Most life decisions you are making will have some type of financial impact. Switching jobs, deciding if one spouse will stay home with the kids, starting a business – it can be stressful not knowing how these decisions will impact your longer term goals.

Financial planning is a process, meaning that your financial plan adapts as you make these decisions so that you can have a more clear picture of how each one could impact you in the future.

3. You’re busy and don’t want to be focusing your time and energy on this

There’s no question you could spend time googling answers to your financial questions and thinking through how to apply that information to your situation. But most young families are at the busiest point in their lives between working and shuttling kids back and forth between activities.

Working with a financial planner gives you the ability to outsource the legwork involved in researching the options available. And having a financial plan in place allows you to foresee upcoming financial decisions and be proactive in thinking through them.

4. You have time to make adjustments

This is the time to get a handle on your financial situation because you still have plenty of time to make adjustments. Maybe you’re not saving enough for retirement, need to shift which goal you are prioritizing, or want to get out of debt.

When you’re 20 or 30 years away from retirement, you can make adjustments and still give your money plenty of time to work for you.

5. You have others who rely on you

When you have others that are impacted by your financial decisions – kids, a spouse, aging parents – the gravity of your decisions can be felt more strongly.

When you work with a financial planner to establish your plan, you have someone to bounce ideas off of and offer an unbiased opinion when needed.

We love working with young families as you navigate difficult financial decisions and set yourselves up for the future – check out how we’re doing that here.

Are you interested in staying up to date on new articles and other news from us? Sign up for our newsletter or follow us on Facebook and Instagram.

Ready to learn more about how we can work together? Schedule an introductory call.

The post 5 Reasons Young Families Need a Financial Plan appeared first on Still River Financial Planning.

Roth vs. Traditional 401(k): How to Choose

amyfunahahsi — Fri, 29 Jul 2022 20:06:00 +0000

Many companies now offer the choice between making Roth 401(k) contributions or traditional 401(k) contributions (or both!).

Before we get into how to decide the best approach for you, let’s cover a few of the basics.

What is the Difference Between Roth and Traditional?

These are some of the key attributes of Roth and traditional 401(k)’s:

Roth

Roth contributions are made with after tax money, so there is no tax break in the year that you make the contribution.
Withdrawals are completely tax and penalty free if you’re over 59 ½ (see one exception below).
For earnings in the account to be withdrawn tax free, your first contribution to the account must have been at least 5 years prior.
You have to take required minimum distributions (RMD’s) from the account starting in the year you turn 72. However, if you roll the money over to a Roth IRA, there is no requirement to take RMD’s.

Traditional

Traditional 401(k) contributions are made with pre-tax dollars, so you get a tax break in the year you make a contribution.
Withdrawals are taxed as ordinary income, in the same way your salary is taxed.
RMD’s are a must, starting in the year you turn 72.
As with Roth accounts, there is a 10% penalty for most withdrawals taken before age 59 ½.

One additional note: employer matching or profit sharing contributions are always considered traditional contributions, so ordinary income tax is paid when they are withdrawn.

Now let’s take a look at how to decide which type of account is most beneficial to you.

The Key Consideration – Tax Rates

The most important factor in deciding between Roth or traditional contributions are your current and future tax rates.

If you expect to be in a lower tax bracket when you withdraw the money, taking the current tax benefit of the traditional 401(k) would be best.

A Roth would be more advantageous if you are in a low tax bracket today and anticipate paying a higher tax rate in the future when you can withdraw the money tax free.

If you’re not sure how your current tax picture compares to what it may be in the future, you could split contributions between each of the options.

The Best Tax Planning Strategy

While no one knows for sure what their tax rate will be in the future, the reality is that our income levels can fluctuate throughout our lifetimes.

Maybe one spouse decides to stay home with kids for a period of time, or maybe you start a business, or know that a big bonus is coming your way in a year or two.

When you have this type of variable income, you can switch between Roth and traditional contributions depending on your income level for that year.

In high income years, reduce your tax bill by making traditional 401(k) contributions, and in lower income years, pay the lower tax upfront by making Roth contributions.

This gives you the best chance to minimize the taxes you pay over your lifetime.

Other Considerations

While tax rates are the primary consideration when deciding between Roth and traditional contributions, there are a few other differences between these accounts that may factor into your decision making process.

Estate planning

Roth IRA’s in particular have significant value as an estate planning tool. And if you roll your Roth 401(k) into an IRA, you can take advantage of this.

Roth IRA’s have no RMD requirement, so money can be left in these accounts until you die. And if you leave a Roth IRA to your children, they will pay no taxes when the money is distributed to them.

Charitable Giving

If you’re charitably inclined, traditional IRA’s have a benefit that could allow you to make charitable contributions with money that never shows up as income on your tax return.

Qualified charitable distributions can be made beginning in the year you turn 70 ½. These distributions are tax free and are not reported as income on your tax return, which is important for minimizing taxes you pay on social security income and premiums you pay for medicare.

Final Thoughts

Whether or not a traditional or Roth 401(k) is best for your situation can be a little bit of a guessing game based on where you expect your tax rates to be in the future.

And as with most personal finance decisions, everybody’s situation is unique and there are many variables in your personal life that impact what you should do.

If we can help, get in touch with us here!

Are you interested in staying up to date on new articles and other news from us? Sign up for our newsletter or follow us on Facebook and Instagram.

Ready to learn more about how we can work together? Schedule an introductory call.

The post Roth vs. Traditional 401(k): How to Choose appeared first on Still River Financial Planning.

When It Comes To Investing, Focus On What You Can Control

amyfunahahsi — Fri, 22 Jul 2022 20:05:00 +0000

Deciding what to invest your money in can be a confusing process. There are thousands of stocks, bonds, and mutual funds to choose from. So it’s important to focus your decision making process on what you actually have control over.

What You Can’t Control

What the market does in the short term

There is no question that the stock market can be volatile over short periods of time. However, when you look at long time periods of 10-15 years or more, the market historically has done very well.

This is why it’s important to choose investments with a long term mindset. And instead of focusing on what has performed well recently, focus on making sure you are truly diversified.

Which companies or funds outperform

The SPIVA U.S. Scorecard for 2021 shows that the overwhelming majority of actively managed funds (those that attempt to perform better than the market as a whole) underperformed their benchmarks over the last 3, 5, 10 and 20 year periods.

In this table, you can see the percentage of these funds that underperformed:

This tells us that it’s very difficult for even professional investment managers to perform better than index funds which track the market as a whole. And over the long term, it’s virtually impossible.

What You Can Control

Asset Allocation

The first step in deciding where to invest your money is to determine:

Your risk tolerance, or how much risk you can personally handle; and
Your risk capacity, which is how much risk you can afford to take based on your time horizon.

This will help you get a feel for how much of your money should be put into riskier assets (like stocks) with a greater chance of future growth. And how much should be in safer assets (like bonds).

Diversification

There are a couple different ways to think about diversification. You should diversify across different asset classes with different levels of risk, like stocks and bonds.

But within your stock holdings, you should also be diversified across geographies (US, International, Emerging Markets) and company size (sometimes referred to as market cap).

Diversification is a must since we can’t foresee the future in terms of what will happen in the market.

Fees

Controlling the fees you pay is one of the easiest ways to give yourself a leg up. Mutual funds and ETF’s charge a percentage of the amount you have invested to cover administrative and other expenses.

The percentage charged can vary widely depending on what type of fund you invest in. So take this into account since it has a direct impact on your investment returns.

Tax Efficiency

Funds that are actively managed tend to be less tax efficient. This means that buying and selling investments within the fund can create income that is passed down to the fund’s investors.

You could then be on the hook for paying taxes on this income depending on the structure of the fund and where the investment is held. In general, the more tax efficient the fund, the fewer taxes you will have to pay.

To evaluate tax efficiency, compare the turnover ratios of funds you plan to invest in. This represents the amount of buying and selling that happens within the fund.

Takeaway

Nobody truly knows what the stock market will do in the future. But you have some say in how much you pay in fees and taxes. And you can always make sure you are appropriately diversified.

Focus on what you can control when deciding how to invest your money, and make sure you are in it for the long term.

Are you interested in staying up to date on new articles and other news from us? Sign up for our newsletter or follow us on Facebook and Instagram.

Ready to learn more about how we can work together? Schedule an introductory call.

The post When It Comes To Investing, Focus On What You Can Control appeared first on Still River Financial Planning.

What is Fee-Only?

amyfunahahsi — Fri, 01 Jul 2022 20:04:00 +0000

There are several ways financial planners can be compensated, which can make things confusing.

We work with clients on a fee-only basis, so I thought I’d share a bit more about what that means and how it’s different from other models.

The Fee-Only Model

Fee-only financial planners are compensated in one way only – fees paid directly to them by their clients.

This fee can be based on the amount of assets the advisor manages for you, an hourly fee, or a subscription fee based on other factors like complexity or income. We do not manage assets for clients, so we take a unique approach to determining fees.

Fee-only financial planners do not sell any products – like insurance or mutual funds – and don’t have any restrictions on the types of investments or insurance policies they can recommend to clients.

The fee-only model is typically thought to be the most transparent way to charge for financial planning services. And it eliminates a significant amount of the conflict of interest that arises when financial planners sell products in addition to giving advice.

Commission Based

Advisors who are commission based make money by selling products they earn a commission on. This could be life insurance, annuities, or investment products like certain types of mutual funds.

Commissions are typically paid by the insurance or investment companies that create the products, so it may seem as though you are paying nothing or very little. But these costs are typically passed down to the consumer in some way – many of these products come with large fees attached. So it can oftentimes be more difficult to determine exactly what you are paying.

Fee-Based

Fee-Based advisors take a bit of a hybrid approach. Typically, they charge a fee based on the amount of assets invested with them. But, they can still earn commissions through product sales as well.

Conclusion

I am of course biased toward the fee-only model. I truly believe that the transparency provided is incredibly important. But, different models can work for different people. The key is to be aware of how you’re being charged and to understand what potential conflicts of interest exist.

Are you interested in staying up to date on new articles and other news from us? Sign up for our newsletter or follow us on Facebook and Instagram.

Ready to learn more about how we can work together? Schedule an introductory call.

The post What is Fee-Only? appeared first on Still River Financial Planning.

The Best Ways to Save for Your Children

amyfunahahsi — Fri, 24 Jun 2022 19:52:00 +0000

You want to set your children up for financial success, but what’s the best way to do that if you have some extra money to set aside for them?

This article will give some insight into how to think about choosing the best savings method based on your goals.

Clarify Your Goal

You first need to clarify what you’re actually saving for and trying to accomplish.

Do you want to put money away for college so that your kids will graduate with minimal student loan debt? Do you want to save some money to give them a head start after moving out? Or maybe you want to help them get a jump on retirement savings.

Saving for College

Many parents first and foremost want to help their children get through college. And rightfully so – graduating with little or no student loan debt can be a huge benefit for a 22 year old still figuring out what they want to do.

If this is you, check out this guide to picking the best college savings account. 529 accounts have become the most popular and typically most advantageous savings vehicle for college. But if you want to save for one of the other goals mentioned above, keep reading to learn about your options.

Custodial Roth IRA

If your goal is to help your kids start putting money away for long term savings, a Roth IRA can be a great tool.

Tax Impact

Since the money grows completely tax free, the compounding benefits can be huge with such a long time horizon.

The downside is you can only contribute up to the amount of earned income the child has. But if they earn money from babysitting, mowing lawns, or any part time job, you can contribute to the Roth IRA for them up to the amount of income they earned. You could also consider matching their own contributions to encourage them to save some of the money they are making as well.

Because of the tax advantages of the Roth IRA, earnings within the account cannot be withdrawn (in most cases) until age 59 ½ without having to pay penalties.

Financial Aid Impact

When it comes to applying for financial aid, Roth IRAs have no impact as long as the child doesn’t withdraw anything from the account.

Legal Ownership

At age 18 or 21 (depending on your state), the child will take full ownership of the account. So it’s important to educate them about the potential penalties incurred from early withdrawals.

Outside of a college savings account, a Roth IRA is one of the most effective ways to save for children. There are not only tax and financial aid benefits, but also the ability to teach your children about saving and investing with a wide range of investment options available.

Custodial Brokerage Accounts

A custodial brokerage account may be the way to go if you want your child to have access to the savings before retirement, but don’t want to be pigeon holed into using the funds for college.

Tax Impact

Beware that investment earnings within this type of account are subject to the “Kiddie Tax”, which is in place to ensure parents can’t transfer a significant amount of investment income to their children to be taxed at a lower rate.

This means that for 2022 the first $1,150 of unearned income (this could be dividends, interest, or capital gains), is taxed at 0%. The second $1,150 is taxed at the child’s tax rate. And anything over $2,300 of unearned income is taxed at the parents’ tax rate.

Financial Aid Impact

Custodial brokerage accounts have unfavorable financial aid treatment. They are considered assets of the child, which means 20% of the account balance is included in the calculation of your expected family contribution.

Legal ownership

Similar to a Custodial Roth IRA, the child takes full ownership of the account when they reach the age of majority in your state.
However, the brokerage account allows for more flexibility since there are no rules around when the funds can be withdrawn or what they can be used for.

A Brokerage Account in Your Name

If the child having legal ownership of the account at 18 or 21 concerns you, open a brokerage account in your own name.

Earmark the account to be given to your child at some point in the future. They can still have the benefit of learning about saving and investing and watching their money grow.

You can then gift the account to them when you’re ready.

Tax Impact

Earnings in accounts in your name will always be taxed at your tax rate.

Financial Aid Impact

Accounts in the parents’ name do count against you for financial aid purposes. But only up to 5.64% of the account balance factors into the calculation of your expected family contribution.

Legal ownership

Since the account is in your name, your child would only have legal rights to the money once you change ownership of the account over to them. If it ends up being a significant amount of money, be sure to consider gift tax rules and filing requirements. In 2022, a couple can gift up to $32,000 each year to a child without any consequences.

Final Thoughts

There are several options when it comes to saving for your kids. Take some time to think about what your goals truly are for the money. And finally consider the variables of taxes, financial aid, and legal ownership of each option before making your decision.

Are you interested in staying up to date on new articles and other news from us? Sign up for our newsletter or follow us on Facebook and Instagram.

Ready to learn more about how we can work together? Schedule an introductory call.

The post The Best Ways to Save for Your Children appeared first on Still River Financial Planning.

Should Young Families Prioritize Paying Down Debt or Saving for Retirement?

amyfunahahsi — Fri, 17 Jun 2022 19:48:00 +0000

One of the biggest areas we help young families with is prioritizing how to put each dollar you earn to work. Paying down debt and saving for retirement are usually high on the list of priorities.

Here is the thought process we walk families through:

Prioritize Paying Down High Interest Debt

Typically, high interest credit card debt should be prioritized over retirement savings. The key factor is whether your retirement savings can out-earn the interest rate you are paying on the debt.

With the high rates on most credit cards, it’s very unlikely you’ll earn more in the stock market than the interest you are avoiding by making additional payments on a credit card balance.

The one exception is if you have an employer retirement plan, like a 401(k) or 403(b), where your employer matches a portion of your contributions. This type of matching contribution is additional compensation that you’d otherwise be missing out on.

In this case, contribute enough to get the full employer match, then start to tackle your high interest debt.

Think About Emergency Savings

One piece of this prioritization puzzle that is often overlooked is building up an emergency fund. After paying down your high interest debt, make sure you have 3-6 months of expenses saved and easily accessible.

There’s no sense in stashing savings into a retirement account only to have to pull it out and pay penalties to cover unexpected expenses.

Focus on Retirement Savings

Prioritize retirement savings over making extra payments on lower rate auto loans, student loans, or a mortgage. When invested properly, the compounded growth on your retirement savings should outweigh the interest you pay on the debt over the long term.

If you have debt with an interest rate greater than 5-6%, that’s when it makes sense to stop and think about how to allocate your extra cash. And if you’re struggling to decide the best course of action, put some money toward retirement savings and some toward paying down the debt.

A Note About Mortgages

Young families should be particularly careful about prepaying a mortgage before saving for retirement or other financial goals. You’re not only paying down low interest debt, but also putting your money into an illiquid asset that has historically earned less than the stock market.

Final Thoughts

Everyone’s situation is different, but this gives you a place to start when prioritizing how to put your money to work. As with most things when it comes to financial planning, the most important part is to be intentional and thoughtful about your decisions.

Click here to download our free guide: 5 Financial Mistakes Made by Young Families and How to Avoid Them

Are you interested in staying up to date on new articles and other news from us? Sign up for our newsletter or follow us on Facebook and Instagram.

Ready to learn more about how we can work together? Schedule an introductory call.

The post Should Young Families Prioritize Paying Down Debt or Saving for Retirement? appeared first on Still River Financial Planning.

5 Ways to Build Flexibility into your Financial Plan and Why It’s Important

amyfunahahsi — Fri, 10 Jun 2022 19:48:00 +0000

Carl Richards is a financial planner and author who has written extensively for the New York Times. He recently wrote:

“We do planning wrong.

It doesn’t matter what kind—financial, business, life… you name it.

Here’s how we typically plan:

1- We put a stake in the ground where we are today.

2- We put a stake in the ground where we want to be in the future.

3- We draw a straight line between the two stakes.”

His point is not that we shouldn’t draw that straight line to where we want to be, but that we have to be aware that our plans never work out exactly as we imagine.

This is why it’s critical to build some flexibility into your financial plan. And as you might expect, this is a significant point of focus for us as we work with young families who oftentimes don’t know exactly what their long term goals are.

Here are 5 ways to build flexibility into your financial picture so that you are prepared for the unknown that life will throw your way.

Don’t Lock Yourself Into Large Fixed Expenses

Fixed expenses are by definition not flexible, so it’s best to keep these under control as much as possible.

Homes and vehicles tend to be the biggest purchases we make that turn into fixed payments. So before making these big commitments, make sure they fit comfortably into your budget.

Build an Emergency Fund

An emergency fund gives you a source of cash for unexpected expenses. This helps keep you on track to meet your financial goals by allowing you to leave your long term savings in place should something pop up that was not factored into that straight line between where you are now and where you’re going.

Every family’s situation is different, but in general, we recommend keeping 3-6 months of money in a savings account for emergencies that may arise.

Tax Diversification

We typically talk about diversification in terms of investing in a broad range of stocks and bonds.

But when it comes to maintaining flexibility in your finances, it’s important to diversify where you are saving. There are three distinct tax buckets your savings can fall into – taxable (taxable brokerage accounts, savings accounts), tax deferred (traditional IRAs or 401(k)s), and tax free (Roth accounts, HSAs).

By saving into all three buckets, you maintain some control over how you are taxed when you withdraw the funds since all three are taxed in different ways:

Taxable accounts that have increased in value are taxed at capital gains tax rates if investments are held for longer than one year. But you pay taxes on dividends or other income while you hold the investment.

Tax deferred accounts are taxed at ordinary income tax rates (similar to your salary), but there are no taxes on income generated from the investments prior to withdrawing the funds.

Tax free accounts are not taxed at all assuming you meet the requirements of the account – for example, Roth IRA’s require the account to be open for 5 years before withdrawals are made, and HSAs require that you use the funds to pay for qualified medical expenses.

By diversifying the types of accounts you save into, you also give yourself flexibility in the timing of your withdrawals. With tax deferred and tax free accounts, there is typically a penalty for withdrawing funds before age 59 ½. Taxable accounts do not have a similar penalty, so they can be ideal if you plan to retire early or have other pre-retirement goals you are working toward.

Have Sufficient Insurance Coverage

Similar to having an emergency fund in place, having appropriate amounts of auto, homeowners, and umbrella insurance will ensure that you don’t need to dip into your savings if you need to make a claim.

Review these policies at least every few years and evaluate the amount of coverage you have. If the value of your home has increased significantly, assess whether the increases in your coverage (many policies automatically increase your coverage by a small percentage each year) have kept up with the increased cost to rebuild.

If you don’t have umbrella insurance, consider adding it. This insurance adds extra liability coverage for injuries or property damage you could be held accountable for. And typically it’s very inexpensive for the amount of coverage it provides.

Keep a Cash Flow Cushion

If you’re saving the minimum to meet your goals and spending the rest, you don’t leave yourself any room for error when that straight line to your goals gets a bit off track.

Think back over the past year about the extra costs that came up that you hadn’t planned for and how these impact your ability to save the amount you want. Kids birthday parties, donations to friend’s charity fundraisers, an entire new wardrobe when your middle schooler shot up three inches overnight. These type of expenses can creep up and make a big dent in your ability to save for your goals if you don’t have extra room in your budget.

Maybe you feel comfortable stretching things a little thin temporarily if you are on a career path with a clear route to a higher salary. But if you are already in your peak earning years, be wary of not leaving yourself that extra cushion.

Overall, we would all love to have a clear, defined path in life, especially when it comes to financial success. But the truth is that life happens. A bit of extra care while completing your financial planning can help allow you to stay on track despite the inevitable ups and downs of real life.

Are you interested in staying up to date on new articles and other news from us? Sign up for our newsletter or follow us on Facebook and Instagram.

Ready to learn more about how we can work together? Schedule an introductory call.

The post 5 Ways to Build Flexibility into your Financial Plan and Why It’s Important appeared first on Still River Financial Planning.