What is Financial Planning?

Jane Young, CFP, EA

Jane Young, CFP, EA

I’m sure you hear the term “Financial Planning” on a regular basis but you may not be sure what it really means.  Financial planning is an on-going, comprehensive process to manage your finances in order to meet your life goals.  The process includes evaluating where you are today, setting goals, developing an action plan to meet your goals and implementing the plan.  Once you have addressed all the areas of your financial plan you should go back and review them on a regular basis.

Financial planning should be comprehensive – covering all areas of your financial life.  The primary areas of your financial plan should include retirement planning, insurance planning, tax planning, estate planning and investment management.    Depending on your situation, your financial plan may also address areas such as budgeting and debt management, college funding, employee benefits, business planning and career planning.  Comprehensive Financial Planning is very thorough and can take a lot of time and energy to complete.  I recommend breaking it into bite size chucks that can be easily evaluated, understood and implemented over the course of time.  

You can work through the financial planning process with a comprehensive financial planner or you can tackle it on your own.  If you decide to hire a financial planner, I encourage you to work with Certified Financial Planner who has taken an oath to work on a fiduciary basis.  An advisor, who works as a fiduciary, takes an oath to put your interests first.

The first step of the financial planning process is to evaluate where you are today.  Tabulate how much money you are currently spending in comparison to your current income.  Calculate your current net worth (assets less liabilities).  Evaluate the state of your current financial situation.  What is keeps you up at night and what should be prioritized for immediate attention?

The next step is to devise a road map on where you would like to go.   Think about your values and set some long term strategic goals.  Using this information develop some financial goals that you would like to achieve.  Once you have identified some financial goals, a plan can be devised to help you achieve them.

Select the area you would like to address first.  Most of my clients start with retirement planning and investment management.  There is a lot of overlap between the different areas of financial planning but try to work through them in small manageable chunks.  Otherwise you may end up with a huge, overwhelming plan that never gets implemented.

Once you have worked through all of the areas in your financial plan you need to go back and revisit them on a regular basis.  Some areas like investments, taxes and retirement planning need to be reviewed annually where other areas like insurance and estate planning can be reviewed less frequently.  Keep in mind that financial planning is an on-going, life long process.

Don’t Let Financial Scare Tactics Steer You Off Course

 

Jane Young, CFP, EA

Jane Young, CFP, EA

It’s a formidable task to sort through the barrage of financial information from all the various media sources.  It can be difficult to separate fact from fiction.  Information is often slanted when a reporter or writer has a subtle personal or political bias.  Even heavily biased information can appear objective if the messenger has a strong belief that their story is factual.   While it’s always necessary to filter information for personal bias, financial messages designed to intentionally mislead can be especially harmful.  We are constantly bombarded by advertisements and headlines that deliberately twist the facts to scare us and encourage us to buy products or services.

All of this may sound obvious; we should be smart enough to recognize when someone is trying to sell us something or trying to pull something over on us.  However, we have to be diligent to differentiate between legitimate news and sensationalism.  Producers and editors of financial magazines, television shows, and newsletters use exciting headlines to increase circulation and keep people tuned in.   It is common for the media to exaggerate negative information to generate an emotional reaction.  As an investor, you need to keep dramatic headlines in perspective and avoid changing course based on media hype.

A more sinister scare tactic is the threat of impending doom used by some unscrupulous people to sell products such as gold, variable annuities, and financial newsletters. Recently several gold dealers have been running compelling marketing campaigns to convince you that the financial world is on the brink of disaster.  They use well known actors with an authoritative flare to scare you into believing your only salvation is gold. Depending on your situation, it may be logical for you to have some amount of gold in your portfolio.  However, you don’t need to convert your entire portfolio to gold just because a few gold dealers imply they have exclusive access to top secret information predicting imminent financial demise.

You should also be on the alert for unethical firms who use scare tactics to sell variable annuities and financial newsletters.  Some unscrupulous salespeople try to scare people into making inappropriate purchases in variable annuities by preying on their need for security.  A variable annuity may be a good option, but don’t be tricked into buying something you don’t want or need due to exaggerated threats about a pending financial disaster.  Additionally, I have recently observed a newsletter editor greatly exaggerate the impact of recent legislation to encourage people to buy his newsletter.

Appealing to our sense of fear is an age old sales gimmick.  Be on your guard, marketing campaigns have become very sophisticated.  Before making any changes, fully understand what you are buying and make sure it fits into your overall financial plan.  Avoid emotional reactions to media hype and salespeople claiming to predict the future in order to sell their products.

Tax Implications of Gifting to Children

 

 

Jane Young, CFP, EA

Jane Young, CFP, EA

Many of you have worked hard and have saved all your life to achieve financial security and a comfortable nest egg.  However, due to current economic conditions your children may be struggling to pay their bills, buy their first home, or start saving for retirement.  You may want to help them right now, when they really need it, but you aren’t sure about the tax consequences.  There is good news! Over the last few years, the tax consequences to gifting have become much less onerous.  

Taxation on gifts is regulated as part of a combined gift and estate tax.  In 2014 everyone has a lifetime combined estate and gift tax exemption of $5.34 million.  If you are married, you have a combined exemption of $10.68 million dollars.  

Additionally, you can annually gift up to $14,000 to any number of recipients without chipping away at your lifetime exclusion of $5.34 million.  Generally, gifts to your spouse or a qualified charity are not subject to gift and estate tax.  If you exceed the annual gift limit of $14,000 to a single individual, you are required to file a gift tax return (Form 709) to report your gift.  However, you will not owe any taxes until you exceed your lifetime exclusion of $5.34 million.  Once the combined exclusion of $5.34 is exceeded, tax is imposed on the person gifting or transferring the assets, not the recipient.

You may want to make gifts to various friends or family members to help them through a rough patch or you may want to reduce your net worth to avoid or minimize estate tax.  By gifting up to $14,000 per year to several different individuals, you can reduce the amount of money that may ultimately be subject to estate tax.  For example, if you are married and have married children with a total of five children, both you and your spouse can each give $14,000 to each child, $14,000 to their spouses and $14,000 to each one of your grandchildren – every year.   This comes to a total of $252,000 in gifts per year that can be legally removed from you estate and avoid estate taxation.

According John Buckley, a nationally recognized Estate and Business Planning Attorney, gifts that are used for most education and medical expenses are not subject to the $14,000 annual gift tax limit.  Direct payment must be made to the educational institution or medical provider and not to the recipient. This is a huge benefit since many gifts are given to cover education expenses. 

Gifting can be a great way to minimize estate tax if you have a large net worth.  However, most of us save just enough to cover our retirement needs.  The desire to help family and friends is very natural, but avoid the temptation to gift money, especially to children, at the expense of your own financial security and retirement.

Pay Down Debt or Save and Invest?

 

Jane Young, CFP, EA

Jane Young, CFP, EA

The decision to pay off debt or save and invest money is a common dilemma.  The best solution largely depends on the type of debt you are dealing with and the interest rate that you are paying.  Not all debt is created equal; high interest rate, non-deductible debt, like credit card debt and consumer financing, is generally a bad use of debt. On the other hand, low interest, tax deductible debt such as a mortgage or a home equity loan is generally a more favorable use of debt.  Financially, it’s usually wise to own your home and few of us can afford to pay cash. 

If you have a lot of consumer debt or a large credit card balance with a high interest rate, you are probably spending a substantial sum just to cover the interest.  You need to pay more than your minimum payment to start working down the debt.  It’s important to pay down debt, but you also need to maintain some liquidity to cover unexpected expenses.  There is no magic formula for how much of your available cash should be used to pay down debt and how much should go toward building your emergency fund.  Everyone needs an emergency fund, and I generally I recommend maintaining an emergency fund equal to about four months of expenses.  However, if you are drowning in credit card debt consider using half of your money to pay down debt and the other half to build up an emergency fund until you have around $2,000.  Continue along this path a while longer, if you want to build a larger emergency fund.

 Without an emergency fund you could fall into a never ending debt spiral.   If you don’t have an emergency fund, you may be forced to run up credit card debt again when the inevitable emergency arises.    

As you make progress toward paying off debt, you may wonder if you should invest some money for retirement or your other financial goals.  Generally, you should prioritize paying down debt if the after tax interest rate on your debt is higher than your expected after tax investment return.  When considering the possibility of investing some of your funds, factor in the risk associated with investing your money.   Investing is subject to fluctuations in the market, but there is no market risk associated with the interest you save by paying down debt.

 Additional factors that may enter into the decision to invest some of your money include the opportunity to get an employer match on a 401k contribution and the potential tax deduction you could receive from contributing to a retirement plan.

Finally, if you pay down your high interest debt and you want to pay your mortgage off early, consider the impact this could have on your tax deductions.  You also need to weigh this against the return you could earn, if the money is invested.

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