Don’t Let These Planning Mistakes Haunt You
Financial planning must be scary, given the amount of people who avoid it or try to do it on their own, unassisted. Many people assume financial planning means funding their 401(k) or Roth IRA, or perhaps having a 529 savings plan for college. While these are critical components of a sound financial plan, this is occasional planning; only focusing on particular needs without looking at the bigger picture. Or conversely they assume financial planning is fee-based financial planning offered by Investment Adviser Representatives (IARs) which oftentimes involves comprehensive wealth management. Planning for your financial future is about the efficient and effective building of wealth, no matter what a family’s income might be. It not only generates wealth to its greatest potential, but it also seeks to protect wealth from taxes or inflation, market fluctuations, or claims from creditors.
The stakes couldn’t be higher. Done correctly, the results of comprehensive planning can be absolutely incredible. Done incorrectly, one could retire pinching pennies, living a reduced lifestyle, subject to budget-related fears and anxiety.
Don’t let these planning mistakes haunt you:
1. Wasting time.
Our most valuable asset is time; and it is a fact that procrastination is the leading cause of financial failure. In other words, procrastination is the thief of time. The time to get started is today, because you want time to work in your favor with saving and investing. A significant portion of our retirement asset growth typically occurs in the last 5 years of the accumulation phase ─ the years that we are setting money aside for future use in retirement. Putting things in place now, before it is too late, is imperative.
2. Wasting money and opportunities.
By wasting money, I don’t mean buying a latte at your favorite coffee shop every morning. That’s a lifestyle choice, and the whole purpose of building wealth is to support your lifestyle. However, people unknowingly waste a lot money on taxes, unnecessary fess, credit card interest, or just plain bad decisions. The real cost of that waste is in lost opportunity cost, discovering what people could have accomplished, had they not misused their resources. This cost can be significant.
For example, I had a 31-year-old client tell me that every year she received a tax refund of $5,000. This is a mistake, in my opinion. She’s allowed the government to have free use of her money for a year. Even worse, she and her husband treated the refund like a bonus to be spent. I showed her that she was missing a major opportunity with a simple calculation. If she saved $5,000 a year, from now until age 67, at 2.5 percent interest, she could have over $300,000. This is the lost opportunity cost of the decision she was making.
Knowing where your money is going and why it is going there is crucial in planning for your financial future.
3. Having all of your money under IRS control.
Taxation can be a major source of erosion for wealth, and retirement can especially highlight this potential danger. If your entire retirement savings is tied up in a 401(k) or other qualified plan, then all of your retirement income may be subject to taxation, at a tax rate that’s impossible to plan for. Conventional wisdom says tax rates will be lower when you retire, because you will be in a lower income bracket. That is not necessarily true. The tax rate is the lowest it has been over several generations. Congress can easily vote to change the tax rates and brackets. If you enter retirement with all of your money in a qualified plan, you risk leaving your retirement lifestyle enormously exposed to unknown tax risk. It is best to consider diversifying with some tax-free retirement income options and strategies.
4. Not having adequate protection in place.
When bad things happen, you want to ensure you are protected. You want to protect against premature death by having life insurance- enough to replace your lifetime income- but protection is more than just life insurance.
You probably have insurance on your vehicles and your home, but is it really enough to protect you? A large percentage of the people we encounter in this industry do not have umbrella policies, which provide additional liability coverage above what an automobile or homeowner policy includes. Without an umbrella policy, everything ─all of your assets and future income (excluding what is in a qualified retirement account) ─ is at risk of a lawsuit. My wife was rear-ended in a minor car accident a few weeks ago. In the next few days after the accident, she received 23 phone calls from law offices asking to help her file a lawsuit. That is scary.
There are many more forms of protection to consider. Disability insurance, for example, protects your ability to earn an income in your chosen profession, in the event that you are injured or too sick to work. This needs to be structured correctly, so you receive tax-free payments. Medical and long-term care, chronic illness benefits, checking the accuracy of your Social Security records, writing a Will, and putting an Advance Medical Directive and Durable Power of Attorney in place ─ these are all things that fall under the category of putting adequate protection in place.
5. Not building in flexibility and liquidity.
Life is full of changes, so we want to structure our financial lives in a flexible way. One client I know has $400,000 saved in 529 plans for his two children. He recently told me that one of his sons just received a full scholarship to college! Unfortunately, he cannot use the extra money from the 529 account for a non-educational purpose without incurring taxes and penalties.* Your finances should be organized in a way that money is not locked in a vehicle that can only be used for one specific purpose. This could be avoided by incorporating a strategy that would allow the flexibility of the use of money for other purposes.
The other side of liquidity is having enough at your disposal to support your lifestyle. We have no idea what lies ahead with technological and social changes over the course of our retirement years, not to mention medical issues, lawsuits, and other unexpected expenses. You need to save enough to give yourself a liquid cushion. One basic bit of advice? Save at least 15 percent of your income. This will keep the ghosts of bad financial decisions from haunting you in the future.
Planning for your financial future does not have to be scary and planning mistakes do not have to haunt you! Work with a qualified financial professional that uses a process that measures protection, savings, growth, debt, and, most important of all, cash flow. Don’t go through life concerned about what is behind the next door!
* 529 plans may be rolled over to another qualified family member.