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Tax Planning

One Marshmallow or Two?

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A decades-long study has been conducted with children using marshmallows to determine their ability to make long-term decisions. The experiment is simple. Children are presented with a marshmallow; the person conducting the experiment tells the children they can eat the marshmallow now, or if the child waits 15 minutes before eating the marshmallow, the child will be presented with a second marshmallow. The child has to decide if it is worth waiting the grueling 15 minutes before eating the marshmallow in order to have two marshmallows. The study tracks the percentage of children who have self-control and long-term thinking capabilities to forgo immediate gratification for a larger reward in the future.

What if you were offered $10,000 today that you could spend as soon as you want, but if you waited 30 years to spend the money, you would be given $1,000,000? This is a choice you make when you save for your retirement. Thirty years is a lot longer to wait than the 15 minutes for the marshmallow, but the requirement for long-term thinking is still needed to end up with the better outcome.

As a financial planner, one of the best parts of my job is watching the families I take care of enjoying their life after work. The stories about the trips they take, or seeing them spend their winters in Florida, or the joy they have when they talk about not having to wake up early on Monday mornings to drive to work – this drives me to help more families reach this mountain top. But the reality is, this dream was not accomplished overnight. It took years of sacrifice, discipline, and patience to get to the point where they could officially leave the workforce.

Saving for retirement is not rocket science. What I mean to say is that you do not need a degree in finance or a deep understanding of the stock market to have success in the stock market. So why don’t more people retire with more money in their investments?

Because saving for retirement requires the discipline to live on less than you make. It requires saying no to newer vehicles or saying no to expensive vacations. It requires paying attention to the dollars that come in and the dollars that go out. This is not difficult in an academic sense, but it is very difficult in a behavioral sense.

Popular culture pushes all of us towards instant gratification. We live in a consumer-driven economy. Keeping up with the Jones’s is not a new phenomenon, but it is nevertheless more prevalent with the addition of social media that floods our feeds with images of families taking big trips or buying new homes. We are constantly being told to eat the marshmallow.

Your life after work starts with a vision. This vision provides a focus point, and it reminds you when you add money to your investments, rather than adding money to your standard of living, that waiting for two marshmallows will be worth it.

Financial Enhancement Group is an SEC Registered Investment Advisor. Securities offered through World Equity Group, Inc. Member FINRA/SIPC. Advisory services can be provided by Financial Enhancement Group (FEG) or World Equity Group. FEG and World Equity Group are separately owned and operated.

Patience Pays Off

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Good things come to those who wait. This is true in multiple aspects of life. However, in today's world where information, entertainment, and consumerism are delivered at incredible speeds, waiting is often seen as a negative. But not everything can be delivered overnight – long term investment success being one of them. Choosing to save a percentage of your income and making daily choices to live on less than you make is the most common way for everyday Americans to retire with dignity.

Long-term investors go through three phases of finance: accumulation, preservation, and distribution. Preservation and distribution are both important, but they are optimized with proper planning and decision-making during the accumulation phase. The accumulation phase requires patience and fortitude because progress is very slow in the short term, but you are planting seeds that will make a significant impact on your investments and the taxes you will be subject to pay in retirement.

The most important things to focus on in accumulation are systematically saving the right percentage of your income and building tax diversification amongst your investments.

During accumulation, the amount you are contributing to your investments on an annual basis will most likely be more impactful than the return your investments create. Choose investments that match your time horizon and risk tolerance, but do not get discouraged when the investments do not generate a high return every year – just keep making contributions. Your average return becomes most important in the preservation phase – this is when your investment return becomes more impactful than your annual contribution.

Accumulation is also the best time to start building tax diversification within your investments. Most long-term investors have great savings habits and are motivated to see their savings grow over time, but they rarely think about the tax consequences of taking money out during the distribution phase. And if you have not done the planning prior to retirement, you will be forced into a tax rate that you have little to no control over.

The three main types of investments accounts include tax-deferred, Roth, and taxable. Tax-deferred contributions go into the account tax free and grow tax free, but distributions are taxed at ordinary income rates and must come out after age 59 ½ to avoid early withdrawal penalties. Roth contributions have already been taxed and grow tax free, and all distributions after age 59 ½ are tax and penalty free. Taxable accounts are taxed each year based off the dividends, interest, and realized capital gains that are generated, but you are not taxed on the distribution amount, and you can take a distribution at any age without a penalty. Pros and cons to the tax treatment are prevalent for each type of account – to have the most control over your tax rate in retirement, investors should spread their savings among each type of account.

The exponential variable in the compound interest formula is time. The earlier you start saving, the more impactful the end result will be. Use the time you have to your advantage.

Financial Enhancement Group is an SEC Registered Investment Advisor. Securities offered through World Equity Group, Inc. Member FINRA/SIPC. Advisory services can be provided by Financial Enhancement Group (FEG) or World Equity Group. FEG and World Equity Group are separately owned and operated.

What is Tax Planning?

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In business they say, things that are measured do well, and things that are measured and reported do tremendously better. Sadly, most taxpayers skip to the reporting and never do the measuring! You have to pay your taxes and you have to do tax reporting. Tax planning is an extra step offering significant value for your financial journey. Tax planning is the “measuring” and must be done before the end of the year. This is where you adjust investments and income to maximize your tax opportunities.

You've probably heard Einstein’s definition of insanity, which is when you do the same thing over and over, and you expect a different result. That's what happens almost every year with most people's tax return. They do not make any changes or do anything different. They do not do any proactive tax planning, but they hope for different results! Suddenly, April 15th rolls around and you have to pay the IRS. The tax season is an ongoing annual process of frustration.

You can’t make any changes – short of IRA contributions – after December 31st. April 15th is 112 days into the next year, so it’s not front and center on your mind around the holidays. But it should be if you genuinely care about your retirement. It's your financial journey and tax planning is necessary for success.

Think about our progressive tax system as a series of stair steps. The more you earn, the higher up the steps you go starting from 0% moving all the way up to 37%. The first objective in tax planning is to know your marginal and effective tax rates. The effective rate is what you pay on the average dollar you earned. The marginal rate is where your last dollar was taxed. You recognize the taxation on each of the steps along the way making your average tax rate lower than your marginal rate. When doing financial planning, it is the marginal rate that matters most.

If you are married filing jointly, your first $19,000 of earnings after your deductions will be taxed at 10%. Then, you’re going to take a step up and it will be a 20% increase to the 12% bracket and so forth. The goal is to stay in that 12% bracket or lower whenever possible as there are significant tax advantages at those rates.

With the changes beginning January 1st, 2018 to the tax, many taxpayers will find themselves no longer itemizing. That changes many tax planning opportunities, but it doesn’t shut the door on good planning. There is still Bracket Bumping, Double Stacking, Qualified Charitable Distributions (QCDs) and gifting strategies that can be explored.

Tax reporting is what you do every April. Tax planning is what you have to do before the end of the year. Don't miss the deadline. You’ll be disappointed in the years to come when you recognize what opportunities you missed.

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see our Disclosure page for the full disclaimer.

9.1.18 Longest Bull Market, Tax Returns & Tax Planning, Finding the CPA You Trust, Family Bundle, and Peer Review in IRA World

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Welcome to this week's Consider This with Big Joe Clark radio show, hosted by Joe Clark, CFP. This episode originally aired on September 1, 2018. To find our podcast, check out Consider This Program.

In this episode you will find information about:

Longest Bull Market, Tax Returns & Tax Planning, Finding the CPA You Trust, Family Bundle, and Peer Review in IRA World

Questions or comments about this episode, please click here.

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