How do you define “barrier”?
Webster’s Dictionary defines it as “an
obstruction such as a fence or anything that hinders or blocks your way”.
However, there are several different definitions people can use to define
barrier, especially when you are talking about your finances.
Financial Barriers can be defined as:
- losing a portion of your initial investment
- not earning enough to out pace the cost of inflation, or
- the possibility of out living your savings
No matter how you define financial barriers, they affect all of us everyday.
There are three primary reasons why people plan:
- To accumulate wealth: You may have certain goals in life, whether
it is to save for college, purchase a home, or ensure your financial
independence during retirement, proper planning will help you achieve those
goals.
- To generate income: At some point in life we would like the choice
to stop working and stop saving and just enjoy life. At that point, we would
like our savings to cover our lifestyle and allow us to do the things we
enjoy.
- To preserve wealth: Wealth preservation is an important objective
throughout your life, especially after retirement. During retirement there can
be several factors which can cause a reduction of wealth such as: unexpected
nursing home expenses, income taxes and poor stock market investments.
How do you determine what type of investments are best suited to meet your
primary goals? The type of investment and the amount of your investments should
be determined by your current and future personal financial objectives. As you
enter different stages of life, your financial objectives and risk tolerances
may change. Understanding your objectives and potential risks will help you
diversity your investments in order to avoid the 10 barriers to financial
success, which are:
No one can predict when that “rainy day” will arrive, but when it does,
access to cash is critical. Investors should keep some money available in liquid
investments that can provide a cushion for those rainy days. As a general rule
of thumb, liquid cash should equal approximately 6 months salary (after tax).
Money Market Funds
A money market fund allows you access to money when you need it. In addition, by
investing your “available” cash in a money market fund, it will earn dividends
until you need it.
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Investments fluctuate, but some investments are clearly “safer” than others.
Investments that offer a guaranteed fixed interest rate may provide more
stability and less risk of loss of your original investment. However, short term
fluctuations can effect even high-quality long-term investments. For example,
you can suffer a setback in a long-term investment if you are forced to sell it
to meet a short-term need.
Fixed Annuities, Treasury Bonds and Certificates of Deposit (CD)
These types of investments can provide you with an increased income while
preserving your initial investment. Fixed annuities are long-term retirement
vehicles issued by insurance companies. They provide a fixed rate of interest
for a specified period of time and accumulate tax-deferred. U.S. Treasury bonds
are long-term debt instruments issued by the U.S. Government. They represent
direct debt obligations of the U.S. treasury department and pay semi-annual
interest payments. Treasury bonds are generally issued with maturities of 10 to
30 years. A CD is a type of investment product issued by a bank that usually
pays interest with a minimum term, minimum initial investment and is FDIC
insured up to $100,000.
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Inflation occurs when the “actual” value of money goes down as a result of
the price of goods and services going up. As we know, the prices of items we use
everyday go up each year. So if you own only investments paying a fixed rate of
income over 10 years you will see your purchasing power decline. Take a look at
how prices have increased over the last 20 years, as determined by the Consumer
Price Index.
Postage Stamp
161% increase
1977 - $.13
2002 - $.34 |
Loaf of Bread
279% increase
1977 - $.33
2002 - $1.25 |
New Home
165% increase
1977 - $67,130
2002 - $180,200 |
Equity Mutual Funds, Variable Annuities, Individual Stocks
A stock is a share of ownership or equity in a corporation. A corporation’s
financial performance chiefly determines the value of its stock. Over the long
haul, stocks as stand alone investments or as part of mutual funds or variable
annuity sub-accounts, have outperformed other “safer” investments such as bonds
and Treasury Bills, and have proven to be most effective at building investor
wealth. You can see this by looking at the Dow Jones Industrial Average which
has increased from more than 900 in 1981 to over 10,000 in 1999.
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Dis-inflation or a slowing rate of inflation is caused when prices increase
at a slower rate. One thing that can cause dis-inflation is competion. For
nearly the past 10 years Coca-Cola and Pepsi have sold soft drinks in vending
machines for around $0.60. So you can see how competition can cause prices to
fall or remain the same.
But what does all this have to do with investing? For clients who are
investing for income in fixed securities, the outlook for inflation greatly
affects the direction of interest rates, and therefore the amount of money you
earn on your investment. While dis-inflation can be good news for day-to-day
costs, it can be bad for the interest rates of your investments. As inflation
slows, interest rates fall.
Fixed Annuity, Long Term Bonds
A long-term bond represents a contractual obligation of the issuer. An
individual who purchases a long-term bond is actually lending money to the
issuer, while receiving interest on the loan, along with an agreement to pay
pack the principal at a stated date in the future. By investing in long-term
bonds or fixed annuities, your rate is “locked in”. This becomes critical when
interest rates are declining because you have already established your set rate.
Compare this to a one year Certificate of Deposit where your rate would change
after that one year. If rates have dropped your would then earn the lower rate.
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When many individuals invest, their primary objective is to seek an
investment that will maximize their return. While this is very important, many
investors overlook the impact of taxes on their investment return. If you
consider that state and federal income taxes can easily wipe out almost
one-third of your investment return, taxes become a very important consideration
in the investment decision making process.
Retirement Accounts, Annuities and Municipal Bond Funds
Reducing or eliminating current income taxes on your investment could be one
solution to making the most of your investment dollars. This can be achieved
through the power of tax-deferral or tax-free investing.
Examples of tax-deferred investments are:
Individual Retirement Arrangements
Traditional IRA – A long-term retirement vehicle which allow you to
contribute $2,000 or 100% of your compensation annually, whichever is less.
Contributions may be deductible for federal income tax purposes, depending on
whether you are an active participant of an employer sponsored retirement plan.
Roth IRA – A long-term retirement vehicle which allows you to
contribute $2,000 or 100% of your compensation, whichever is less. Generally,
distributions from a Roth IRA are income tax free if the Roth IRA has been held
for 5 years and:
- is taken after attaining age 591/2
- occurs due to death or disability
- meets the criteria for a qualifying first time home buyer distribution
Annuities – These are long-term retirement vehicles that allow your
investment returns to accumulate tax-deferred, while also providing a variety of
income payments. There are two variations of annuities, fixed and variable. A
fixed annuity will provide a fixed rate of interest guaranteed by the issuing
insurance company for a specified period of time. A variable annuity allows you
to invest a sub-accounts, which invest in a series of underlying funds.
Generally, these underlying funds will range anywhere from money markets, to
growth funds, to aggressive growth funds. Due to the nature of these
investments, your contract value will fluctuate with the performance of the
underlying investment.
Tax-Free Investment
Municipal Bonds and Municipal Bonds Funds – These are bonds issued by
states, cities or counties other than the federal government or its agencies.
What makes Municipal Bonds so attractive, especially to investors is a high tax
bracket is, they are exempt from federal income tax. Due to this feature, the
interest rate offered on municipal bonds will be lower than non-exempt bonds.
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Periods of political or economic turmoil will often have an adverse affect on
U.S. investment markets. Recent circumstances such as the Persian Gulf war, the
impeachment of President Clinton or economic indicators that suggest a slowing
economy all may influence temporary declines in U.S. financial investments like
stocks and bonds.
International Investments
Investing in stocks and bonds that invest in foreign markets and economies may
ease some of the volatility you may experience in your portfolio, because the
foreign countries may experience different economic cycles that the United
States. International investing may also provide opportunity that can not be
achieved by only investing in U.S. companies. Many of the worlds largest
companies are based outside the United States.
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Now more than ever, families rely on dual incomes to maintain their standard
of living. Without proper protection, the loss of income from the premature
death of a family member may seriously jeopardize a family’s ability to maintain
their current lifestyle and meet current and future costs, such as a mortgage,
utilities, college tuition and retirement savings.
Life Insurance
It may be the most appropriate vehicle available to protect a family from the
premature death of an important family member. The nature of life insurance
provides for the tax-deferred build up of cash values, while leveraging the
amount of money contributed to the policy by paving an income tax-free death
benefit. There are many different types of life insurance policies available
today. It is always important to consider your overall financial and investment
needs and objectives to ensure you purchase a life insurance policy that is most
suitable to meet your goals.
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Most people realize the importance of health or medical insurance to cover
the costs of possible accidents or illness, but many people don’t consider the
potential loss of income associated with periods of disability. However, for
people of most ages the possibility of becoming disabled due to an accident of
injury is more probable than the possibility of death.
Disability Insurance
This type of insurance is usually most suitable for people under the age of 65,
who desire protection from the loss of income due to disability. The provisions
of Disability Insurance will vary depending on the policy, but generally
speaking disability insurance will provide a monthly benefit ranging between 60%
to 80% of a persons earned income.
Long-Term Care Insurance
Long-Term Care Insurance is another form of disability insurance generally
geared toward older people who wish to protect their asset base from the high
costs incurred from home health care or a nursing home facility. It also allows
people the flexibility to choose their own form of nursing care, and not the
care dictated by a government program.
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Federal estate tax is an excise tax levied on a persons right to transfer
property upon his or her death. An individual’s estate tax could range between
37% to 55% (1) of a persons taxable
estate. A tax of this magnitude could significantly reduce the amount of money
transferred to your heirs, as well as place a burden on the estate if there is
not enough liquid assets available to pay the tax.
There is some relief from tax. In 1999, taxable estates of $650,000 or less
are generally not effected by estate taxes, because of the unified credit
granted to individuals. Each individual has a unified credit that may be used to
offset estate taxes on the first $650,000 of their taxable estate(2) Any amount of taxable estate exceeding the first
$650,000 would then be subject to federal estate tax.(3)
(1) Estates in excess of
$10,000,000 may be subjected to an additional 5% surcharge.
(2) $650,000 is available in 1999, assuming the
unified credit has not already been used to offset gift tax. This amount will
increase in future years.
(3) Estates may also be subject to state estate or
inheritance taxes. For additional information regarding estate taxation, please
contact a tax attorney or professional tax advisor.
Estate Planning
Estate planning can be a complicated matter, especially with larger estates. A
properly drafted will may be the first very important step in this process. This
can ensure that your assets are transferred according to your wishes.
The following are a sample of some of the strategies that may be used to
reduce the size of your estate.
Gifting Program – Individuals may make a $11,000 annual gift per
person without gift tax consequences. This means spouses may make a combined
$20,000 annual gift. If your are married and have three children, you could gift
a total of $66,000 a year, directing $22,000 to investments established in each
child’s name.
Irrevocable Life Insurance Trust – A last survivor life insurance
policy may be one choice used to fund the trust. Because the irrevocable life
insurance trust is the owner of the life insurance policy, it will not be
included in your estate(4). Additionally,
paying the premium on the life insurance policy will further reduce your estate,
while providing an income tax free death benefit payable to the trust upon the
death of the last surviving spouse. You may have the trust drafted to instruct
the trustee to use the proceeds of the death benefit to pay any estate taxes
that may be due or to distribute this money to the named beneficiaries of the
trust.
(4) Gifts of Life Insurance
Policies made within 3 years of death may be included in the gross estate of the
transferer.
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Psychological risk is the risk that you invest in something that causes you
stress or concern about your investment. If for example, you purchase a
long-term investment that is much more volatile than you expected, you may be
less likely to hold that investment to the full term of your initial strategy. A
situation like this may be worse for your overall financial situation than the
actual risk you were trying to protect yourself from. In some cases, you may
never be comfortable with a suggested investment. At this time, you should seek
alternative investment methods to meet your financial goals and only make
decision that you are comfortable with, and that you think is best.
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Call Royce L. Rhea CPA
Royce Rhea CPA*PFS -
royce.rhea@roycerheacpa.com
Norma Ayres - norma.ayres@roycerheacpa.com
1616 Westgate Circle
Brentwood, TN 37027
Phone # (615) 844-2620
Fax # (615) 844-2621
Toll Free # 866-299-2727
At Royce L. Rhea, CPA, we offer a wide range of planning services
that can help you avoid the 10 barriers to financial success.
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