Your Financial Future: What to consider before making a purchase
Often, when I meet with people, I find that they have purchased financial products that may not be in their best interest.
To keep this from happening to you, we will discuss some basics today that you should consider before making any purchase.
There is no perfect financial product. Each has benefits and disadvantages. That is okay as long as you understand the facts and have a plan to deal with any limitations. Every product has three variables. Liquidity is how fast you can turn your investment into cash and at what cost. Risk is what the possibilities of losing your investment are. The third factor is return. If you are taking more risk, you should be getting a higher return. You can usually get two of the three, but not all three.
Money in your bank is very safe and liquid. It pays a very low interest rate that is less than inflation. Money in the stock market is liquid and has the potential for a good return. It does have risk as people witnessed in 2001 and 2008. Money in indexed annuities is safe and can provide a better rate of return. They are not completely liquid. Similar advantages and disadvantages can be stated for all other investments.
The second major area to consider is the tax status of your investments. The Internal Revenue Service recognizes three types of money. Qualified money is investments where you receive a tax deduction for contributing the money to your IRA, 401(k) or similar account. Uncle Sam is your partner.
You must pay taxes at ordinary income tax rates when you withdrawal funds. You must begin withdrawing by at least age 70 ½.
The next type of money according to the IRS is non-qualified. This is money you have left after paying all of your bills. You may acquire it by selling some property, being the beneficiary of a life insurance policy or receiving a gift. You only have to pay taxes on the gains from these funds. Sometimes you get special tax treatment such as capital gains or qualified dividends. These rates may be as low as zero taxes. There are no required minimum distributions and this is your cheapest money to get your hands on. For all of these reasons, this should be your most liquid money.
The third type is Roth IRAs. This must be earned income. You do not get a tax deduction when you contribute the funds. As long as you are 59 ½ or older and have had the Roth for at least five years, there is no tax on the gains. There also are no required minimum distributions. You can always pull out your contributions without penalty just, not the gain.
There are many good companies that offer investment products. No company is the best at everything. Because of this, you should work with someone who offers many company choices and is licensed to show you every type of investment choice. Consider taxes and have a plan to minimize them.
Use a holistic approach to your planning. Consider all of the financial variables such as health care and Social Security planning.
Consider that inflation is starting to rise and markets will not always go up. Warren Buffet recently asked, “Why anyone would buy thirty year bonds?” Don’t make long term choices that lock in low interest rates. Have a plan and work your plan.
Your Financial Future is written by certified financial planner Gary W. Boatman, MBA and CFP, who also wrote the book, “Your Financial Compass: Safe Passage Through The Turbulent Waters of Taxes, Income Planning and Market Volatility.” If there is an area that you would like to see discussed in the column, send your suggestions to gary@BoatmanWealthManagement.com.