October 2011 - Posts - Kahler Financial
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Kahler Financial

October 2011 - Posts

  • Lower Your Investment Tax Bill

    by Rick Kahler

    Maybe Warren Buffett, the second richest man on the planet, doesn't care how much he pays in taxes. For the rest of us, what our investments earn after taxes is much more important than what they earn before taxes. Federal and state income taxes, capital gains taxes, and alternative minimum taxes can reduce your investment earnings by up to 50%.

    It doesn’t take much to substantially reduce your nest egg. If you earned an average of 8% and were taxed at 28%, your after-tax rate of return is 5.76%. A $50,000 investment earning 5.76% grows to $87,536 in 10 years. If that same $50,000 investment isn’t subject to taxes, it grows to $107,946. The higher tax bracket you are in, the more important it is for you to seek out ways to lower your tax bill.

    One of the best tax maneuvers is to invest your money where it will grow tax-free, meaning you will never pay any taxes on the income or accumulation. One way to do this is via a Roth IRA or a Roth 401k plan. All earnings compound tax-free and are not subject to tax or penalties when you take them out of the Roth after age 59½. The downside is that your contribution is not deductible from current earnings.

    Another tax-free investment is interest from municipal bonds. The higher income bracket a person is in, the more an investment in municipal bonds makes sense. For someone in the 33% tax bracket, a 5% interest rate on a municipal bond is equivalent to a 7.46% rate on a taxable bond. But for someone in the 15% tax bracket, it’s only equivalent to a taxable rate of 5.88%. Don’t make the mistake of investing in municipal bonds only because they have tax free income. Be sure the investment makes sense for you.

    After tax-free investing comes tax-deferred investing. This includes traditional retirement vehicles like IRA's, 401k's, 403b's, pension plans, and annuities. Contributions to these plans are pre-tax, while contributions to annuities are after-tax. The earnings are not taxed until taken out, usually after retirement when you may be in a lower tax bracket.

    If you anticipate your overall tax rate (the average percentage of income taxes you pay for the year) in retirement to be over 15%, you’ll want to evaluate whether investments that earn most of their returns in the form of long-term capital gains might be better held outside of a tax-deferred account. That’s because withdrawals from tax-deferred accounts generally are taxed at your ordinary income tax rate, which may be higher than your capitals gains tax rate (currently 15%).

    Look for advice from investment advisors who manage investments in ways that can help reduce the taxable distributions. Investment managers can employ a combination of tactics, such as investing in stocks that don’t pay dividends, counterbalancing the sale of stocks with gains against those with losses, tax harvesting, and minimizing portfolio turnover. As important as minimizing tax is, be careful not to let the tax tail wag the dog. A poor investment doesn't become a good one just because it's tax-free.

    Finally, keep good records of purchases, sales, and distributions so you can accurately calculate the tax basis of your investments. Not keeping good records could mean paying more tax than you should when you eventually sell.

    While you can’t control the direction of the economy and markets, you can have a lot of control over where you invest your retirement funds, the taxes you will pay, and the costs. The tax consequences of investment choices matter to the rich. They matter even more to small investors.

    Rick Kahler, Certified Financial Planner®, MS, ChFC, CCIM, founded Kahler Financial Group, and became South Dakota’s first fee-only financial planner in 1983. In 2009, Wealth Manager named Kahler Financial Group as the largest financial planning firm in a seven-state area. A pioneer in the evolution of integrating financial psychology with traditional financial planning profession, Rick is co-founder and co-facilitator of the five-day intensive Healing Money Issues Workshop offered by Onsite Workshops of Nashville, Tennessee. He is one of only a handful of planners nationwide who partner with professional coaches and financial therapists to deliver financial coaching and therapy to his clients. Visit KahlerFinancial.com today!

  • Will Social Security Be There When You Retire?

    by Rick Kahler

    At the heart of America’s overspending are two popular entitlement programs, Social Security and Medicare. Most Americans count on Social Security for a significant portion of their retirement income and on Medicare for all their retirement health care needs.

    One question I’m often asked is, "Will Social Security be there for me when I retire?" That’s a fair concern when you consider the staggering size of our national debt, which is small compared to the "off balance sheet" liability represented by the unfunded obligations of Social Security and Medicare. Most lawmakers agree off-record that the only way these programs will continue to exist is if we make cuts in benefits and broadly raise income taxes on all taxpayers, not just the rich. Such a scenario probably includes a European-style national VAT (value added tax).

    The good news is that when you take politics out of the equation, saving Social Security could be fairly simple. There are a number of easy fixes that can guarantee its solvency, such as extending the retirement age to 70 and increasing the Social Security tax. I have little worry that seniors currently receiving Social Security will see any reduction in benefits. For those not yet retired, my best guess is the program will "be there" in some shape or form.

    To qualify for Social Security benefits, you need to have worked at least part-time for a cumulative total of at least 10 years. These don't need to be consecutive. There are a lot of myths about how the Social Security Administration computes your benefit. It is computed on your average lifetime earnings of the past 35 years, adjusted for inflation. While having a high salary the last few years of employment will help raise your average, it won’t increase it significantly.

    In their current form, when compared to other similar immediate annuities, Social Security and Medicare are a great deal. They represent a complete security net of retirement, disability, and health insurance benefits that are indexed to inflation. The only little flaw in the formula is that the benefits are so good, we are having to borrow money to deliver them. Only time will tell if Congress increases taxes enough to retain the current benefits or whether we will see some decrease in benefits.

    Currently, while Medicare benefits begin at age 65, the qualifying age for receiving full Social Security benefits is being gradually increased. It tops out at 67 for those born in 1960 or later. Some retirees, however, elect to start receiving reduced benefits (only 70% of the full amount) at age 62. The typical thought is that "a bird in hand is worth two in the bush" and that the present value of saving the five years of reduced benefits offsets waiting until 67 for the higher amount.

    That reasoning is absolutely correct—if the person dies a premature death. There is no easy "rule of thumb" to apply to your specific situation. Generally speaking, even if you retire at age 62, if you are in good health and don’t have a genetic history of cancer or heart disease, you are probably best off waiting until 67 to take your Social Security.

    Of course, if you are still working at age 62, it probably makes sense to wait until age 67 to take your benefit. Any earnings above the $14,160 limit will reduce your Social Security benefit.

    You can estimate what your Social Security benefits will be at www.ssa.gov/estimator/. To receive a written copy of your earnings history and benefits estimate, go to www.ssa.gov/mystatement/. You can also visit a local Social Security office or call (800) SSA-1213.

    Rick Kahler, Certified Financial Planner®, MS, ChFC, CCIM, founded Kahler Financial Group, and became South Dakota’s first fee-only financial planner in 1983. In 2009, Wealth Manager named Kahler Financial Group as the largest financial planning firm in a seven-state area. A pioneer in the evolution of integrating financial psychology with traditional financial planning profession, Rick is co-founder and co-facilitator of the five-day intensive Healing Money Issues Workshop offered by Onsite Workshops of Nashville, Tennessee. He is one of only a handful of planners nationwide who partner with professional coaches and financial therapists to deliver financial coaching and therapy to his clients. Visit KahlerFinancial.com today!

  • The College Credit Bubble

    by Rick Kahler

    The latest bubble forming on the horizon isn’t in real estate or stocks. It’s the cost of a college education, up four times the rate of inflation since 1985—twice as much as health care costs.

    What’s driving this stratospheric rise? Just like the housing crisis, easy credit and poor government policy.

    For decades governments have championed making a college education affordable for all, just as they did home ownership. Since some segments of society couldn’t afford an education or a house, the answer was to encourage lenders to make loans they wouldn't normally have made. This was done by guaranteeing lenders that if the loans went bad, the government would take them over.

    There were two results of this seemingly noble policy. First, with easy credit available, almost any jobless teenager could borrow up to $250,000 for a college degree without a worry in the world of paying it back until graduation.

    Easy credit drives up prices, as the increased demand exceeds supply. Colleges increased tuition at a dizzying rate, simply because they could easily fill classes with students who could easily pay the tuition by painless borrowing. Normal market forces were thwarted, and prices rose exponentially and consistently. Four years of tuition that cost $50,000 in 1985 costs $200,000 today.

    The second result is a replay of the housing crisis. According to an article by Malcolm Harris in the September/October 2011 issue of Utne Reader, students now owe more than $800 billion in outstanding student debt, of which only 40% is in active repayment. The majority of student loans are in default or deferment. Since these debts are guaranteed to the lenders, U.S. taxpayers are on the hook for them.

    The government's artificially gaming markets to give credit to those the market would normally deny, while well intended, causes unintended consequences. The distortions create a new set of problems, sometimes as bad as or worse than those that inspired the attempted fix in the first place. More often than not, most of the parties to the transaction ultimately lose.

    Among the losers are the students themselves. Few take the time to calculate the overt cost of obtaining their education with the corresponding salary it prepares them to earn. But Laurence Kotikoff, professor of economics at Boston University, describes the hidden costs in the September 2, 2011, InvestmentNews. These include the time spent learning rather than earning, plus the progressive income tax which taxes annual earnings rather than lifetime earnings. According to a recent study by economists Stacy Dale and Alan Krueger, going to more selective colleges and universities makes little difference to future income.

    Kotikoff compares two students, neither of whom borrow for their education. One becomes a doctor and the other a plumber. The doctor spends 11 years of her life in school in order to earn $185,895 annually. The plumber spends two years and earns $71,685. The bottom line is that the plumber’s sustainable spending is equal to the doctor's.

    If the government stopped guaranteeing college loans, the initial result would be significantly less demand for a college education. Tuition rates would plummet, eventually becoming affordable once again as the source of easy credit dries up.

    Without easy borrowing as an option, parents and students would be encouraged to begin college saving early. Students would have new incentive to earn money for college and also do well in high school to qualify for scholarships. The result would be more students graduating without debt and feeling less pressure to take the first job available.

    Then, the money that today’s grads apply to student loans could instead be invested in retirement plans.

    Rick Kahler, Certified Financial Planner®, MS, ChFC, CCIM, founded Kahler Financial Group, and became South Dakota’s first fee-only financial planner in 1983. In 2009, Wealth Manager named Kahler Financial Group as the largest financial planning firm in a seven-state area. A pioneer in the evolution of integrating financial psychology with traditional financial planning profession, Rick is co-founder and co-facilitator of the five-day intensive Healing Money Issues Workshop offered by Onsite Workshops of Nashville, Tennessee. He is one of only a handful of planners nationwide who partner with professional coaches and financial therapists to deliver financial coaching and therapy to his clients. Visit KahlerFinancial.com today!

  • Walking for Cash

    by Rick Kahler

    What would it take for you to become financially independent? It's a common goal, and it means different things to different people. I define financial independence as maintaining a lifestyle that supports wellness without having to earn an income.

    Happiness and wellness are not necessarily the same, but recent studies suggest an income of around $60,000 is optimum for producing happiness. This is an average, so the equivalent amount might be around $50,000 in areas like the Black Hills and $100,000 in places like New York City.

    How much of a nest egg do you need to save to produce an annual income of $60,000? To maintain the purchasing power of your portfolio throughout your lifetime, you will want to limit your annual withdrawals to 3% of the principal. This assumes you’ve invested for the long term in a diversified portfolio with the majority in stocks and alternative investments. To throw off the needed income, you will need $2,000,000.

    While two million bucks sounds like a lot of money, accumulating that amount can be done if you start saving early by living on less than you make. A couple who starts contributing $10,000 a year to their Roth IRAs at age 22 and who stop making those contributions at age 29, assuming they invest in equities with an average annual return of 8.5%, will have a reasonable chance of having $2,000,000 by age 65. Similarly, a couple who start saving $10,000 a year in their Roths at age 29 and continues to save until they are age 66 will also have $2,000,000.

    So, how do you save money? The most common denominator among my clients who have accumulated wealth isn’t the career they chose or the investments they made. It’s their ability to understand, apply, and enjoy frugality.

    I asked a friend of mine, a self-made multi-millionaire, how he would explain frugality. He responded, "How would you feel if someone paid you $180 an hour to walk?"

    Then he told me this story:

    "When I travel on short business trips I often leave my car parked at the airport. It’s more convenient and cheaper than the airport shuttle. I got used to parking in the short-term lot because it’s closer to the terminal than the long-term parking. The short-term parking costs $9 a day, while the long-term parking is $8. Many people might figure on short trips they could easily afford the extra $2 or $3 and reap the benefit of reducing their walk to the car.

    However, a frugal person might wonder just how much that benefit would be. I figured out how long it took me to walk the extra steps from the long-term lot to the short-term lot, which was 30 seconds. Walking the same distance on my return makes my extra round-trip walking time 60 seconds. On a three-day trip, my total savings for this one-minute walk is $3, which adds up to $180 an hour.

    To my brain, saving $3 seems trivial and meaningless, but being paid $180 an hour is significant enough to interest me. I’ll sign up for that in a heartbeat. Now, I park in the long-term lot."

    For a successful businessman to care about saving a couple of bucks on parking might seem silly or even miserly. But my friend's story is an example of a frugal mindset. Frugality is choosing not to spend more than necessary on things that don't matter, so you can spend on things that do matter like saving for your future. Then someday, when you're financially independent, people can wonder why you think frugality matters.

    Rick Kahler, Certified Financial Planner®, MS, ChFC, CCIM, founded Kahler Financial Group, and became South Dakota’s first fee-only financial planner in 1983. In 2009, Wealth Manager named Kahler Financial Group as the largest financial planning firm in a seven-state area. A pioneer in the evolution of integrating financial psychology with traditional financial planning profession, Rick is co-founder and co-facilitator of the five-day intensive Healing Money Issues Workshop offered by Onsite Workshops of Nashville, Tennessee. He is one of only a handful of planners nationwide who partner with professional coaches and financial therapists to deliver financial coaching and therapy to his clients. Visit KahlerFinancial.com today!

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