Avoid These Common Mistakes When Choosing a Financial Planner

Before the year’s end, in the midst of the holiday events, travel, and overall busyness, the last thing you want to think about is tackling your finances. But considering how finance-related resolutions are the third most popular New Year’s resolution, why don’t you give yourself a head start on next year’s financial goals by finishing this year strong? Here are ten critical financial actions you’ll be glad you took when the ball drops on New Year’s Eve!

1. Amp Up Your Retirement Savings

If possible, max out your contributions to your 401(k) by the end of the year to make the most of your retirement savings. For 2018, you can contribute as much as $18,500 (or $24,500 if you are age 50 or older). You might also consider contributing to a Roth IRA. For 2018, you can contribute as much as $5,500 (or $6,500 if you are age 50 or older). Keep in mind that if your income is over $199,000 and you’re married filing jointly, you won’t be eligible to contribute to a Roth IRA.

2. Use Your Medical And Dental Benefits

Did you have good intentions of taking care of some dental work, blood tests, or other medical procedures? Now’s the time to take advantage of all your healthcare needs before your deductible resets. Dental plans in particular often have a maximum coverage amount. If you haven’t used up the full amount and anticipate any treatments, make an appointment before December 31st.

3. Verify Expiring Sick And Vacation Time

Depending on your company, your sick or vacation time might expire at the end of the year. Check with your HR department to learn about any expiration dates. If your sick or vacation time does expire, fit in a last-minute vacation, a staycation, or trips to the doctor to use up these benefits.

4. Use Your Flexible Spending Account

Like your health insurance benefits, you’ll want to use up your FSA (Flexible Spending Account) dollars by the end of the year. Your benefits won’t carry over and you’ll lose any unspent money in your account. Check the restrictions for your account to see what the money can and cannot be used for.

5. Double-Check RMDs

If you’re retired, review your retirement accounts’ required minimum distributions (RMDs). An RMD is the annual payout savers must take from their retirement accounts, including 401(k)s, SIMPLE IRAs, SEP IRAs, and traditional IRAs, when they turn 70½. If you don’t, you may face the steep penalty of 50% of the distribution you should have taken. To calculate your RMD, use one of the IRS worksheets.

6. Stay On Top Of Charitable Contributions

If you made a charitable contribution in 2018, you might be able to lower your total tax bill when you file early next year. It can be especially advantageous if you donated appreciated securities to avoid paying taxes on the gains. Along with your other tax documents, find and organize any receipts you have from your donations to charities, whether it was a cash, securities contribution, or another type of gift.

7. Review Your Insurance Coverages

A lot can happen in a year. As you experience life changes, from the birth of a child to marriage to a new career, it’s important to regularly review your insurance coverages and your designated beneficiaries. Now is the ideal time to review your current insurance policies and make sure they are up to date. You might also want to evaluate your need for other types of insurance you may not currently have, such as long-term care insurance.

8. Prepare For A Market Correction

We are currently in the longest bull market in history2 and the stock market just keeps hitting record highs3. But we know that what comes up must eventually come down. Prepare yourself and your money by sticking to a long-term strategy, rebalancing your portfolio, and keeping your emotions in check. As long as you are following sound investment principles, only investing long-term money, and keeping your assets within your risk tolerance, you should have no reason to panic when we experience a market downturn.

9. Talk To Your Kids About Money

The holidays are usually a time for families to get together and reconnect. Use this time intentionally by talking with your kids about money. No matter how old they are, you can give them sound wisdom that will set them up for success. Make sure they understand the importance of saving for retirement and having the proper amount of insurance coverage. Another way to help your kids financially is to create an estate plan to make sure you leave a legacy and avoid passing down a significant tax burden or legal headaches to your kids. If you’ve already taken the time and energy to create an estate plan, you’ll want to check in periodically to ensure all the documents are up to date and no major details have changed.

10. Give Without Gift Tax Consequences

It’s never too early to start planning for the legacy you want to leave your loved ones without sharing a good portion of it with Uncle Sam. You may want to consider gifting. Each year you can gift up to $14,000 to as many people as you wish without those gifts counting against your lifetime exemption of $5 million. If you’ve yet to gift this year or haven’t reached $14,000, consider gifting to your children or grandchildren by December 31st.

1. http://www.statisticbrain.com/new-years-resolution-statistics/
2. https://www.cnbc.com/2018/08/22/longest-bull-market-since-world-war-ii-likely-to-go-on-because-us-is-best-game-in-town.html
3. https://www.usatoday.com/story/money/2018/08/21/stocks-hit-record-highs/922315002/

Most of us know you can use assets in a retirement investment account or an annuity to generate income during retirement. But did you know you can use certain kinds of life insurance policies to do the same thing?

What kind of life insurance?

There are two primary types of life insurance: term and permanent. To use an analogy, think of a term policy as renting a home, and think of a permanent policy as buying a home. Similar to building equity in a home you are buying, permanent policies usually have a feature where they accumulate money inside them called Cash Value. In the same way that a mortgage payment is divided into principal (equity) and interest (the cost of the loan), the premium payment for a properly designed permanent life policy is divided into Cash Value (equity) and the cost of insurance (paying for the actual death benefit). In addition to your own money, the insurance company typically credits your policy with interest or dividends each year, so the Cash Value grows over time.

Note: There are different types of permanent policies (for example, Whole Life, Universal Life, Variable Universal Life, etc.) and they each have their plusses and minuses. Describing the differences would be lengthy and outside the scope of this article. For simplicity’s sake, I’m going to base the rest of this article on Universal Life.

So far, it sounds like an expensive savings account. What am I missing?

Using a life insurance policy to accumulate savings has some key differences from a savings account at your bank. First, the life policy offers tax deferred growth. In a bank savings account, you must report the interest you earn every year and pay income tax on it. The Cash Value in a life policy gets to grow tax deferred, just like in a qualified retirement account. Without having to pay taxes along the way, your money grows faster.

Second, the interest rate that an insurance company pays is typically much higher than the interest rate that a bank will pay on a savings account. For example, at the time of this article, the national average interest rate on a bank savings account is 0.06%1, whereas universal life policies typically average around 3%-5%.2

The biggest difference between Cash Value and a bank savings account has to do with taking the money out. With a bank account, you can only take out the dollars that are there, but there is a way to take money out of a life policy that is leveraged3.

OK, how do I get the money out?

Although the insurance company would allow you to simply withdraw the cash value, that option has a big drawback. The amount of gain in the policy (the current cash value minus the dollars you contributed along the way) would be taxed at ordinary income tax rates. There is a better option.

Insurance companies offer a way to borrow against the cash value in your policy. The proceeds from the loan are tax-free. It is important to note that you are borrowing against the cash value, not from the cash value. That means your entire cash value balance continues to earn interest. Contrast that with any other type of account, where when you withdraw money, the only portion of your money that continues to earn is the money remaining in the account.

Just as with most loans, you must pay interest on the amount you borrow. The life insurance company will typically charge 4%-5% interest. However, the cash value continues to earn 3%-5% interest, so your net cost for the loan might only be 0%-1%. No other vehicle I know of allows you to do this!

But when I’m retired, isn’t taking out a loan a bad idea?

Typically, we want to reduce our fixed expenses during retirement. And typically, adding a fixed loan payment to our retirement budget would indeed be a bad idea. However, taking a loan from your life policy doesn’t add any payments to your budgets. None. In fact, the insurance company doesn’t even expect you to repay this loan during your lifetime. At your death, the loan will be paid off from a portion of the death benefit, while the remainder will go to your beneficiaries. In a well-designed policy, your death benefit will grow over time. This should allow you to borrow tax-free income every year during retirement, pay off the loan when you die, and still have a sizeable death benefit remaining for your beneficiaries.

One small but important caution

What makes this entire strategy possible is the way life insurance proceeds are taxed. Loans taken against the policy are not taxed, nor is the death benefit taxed when received by your beneficiaries. If you take out too much money from the policy and don’t leave enough inside to pay the continuing cost of the policy, the policy will lapse (meaning the insurance company will cancel the policy). If that happens while you are still alive, then the IRS wipes out all of the tax benefits, and all that money you took out becomes taxable. That is a tax bill you want to avoid at all costs.

How do I add this strategy to my retirement plan?

Designing a policy correctly requires experience and advanced training. Many agents who only sell policies and don’t do financial planning may not be properly trained in the intricacies of this strategy. Make sure you get your policy from a reputable advisor who fully understands this strategy, and who can show you how it fits into the rest of your financial plan. This is not the kind of policy you want to buy over the internet or from an 800 number!

https://www.valuepenguin.com/banking/average-bank-interest-rates

Kelly, Patrick. (2007). Tax-Free Retirement

Dictionary.com defines leverage as “the use of a small initial investment, credit, or borrowed funds to gain a very high return in relation to one's investment, to control a much larger investment, or to reduce one's own liability for any loss.” http://www.dictionary.com/browse/leverage