HOW MONEY WORKS, here is a series of questions for you to answer about some of the most basic concepts of traditional financial thinking. The purpose of this exercise is to question traditional financial thinking in order to give you a clearer view of how money works in your personal life.
DO YOU BELIEVE TAXES ARE GOING TO BE HIGHER OR LOWER IN THE FUTURE?
Current demographic and economic trends reveal that, according to the federal government, over the next 20 years the U.S. will be experiencing a declining workforce and an aging population that is living longer and who are receiving government-funded programs. Add to the equation that currently 47% of the workforce pays no federal income taxes and the government’s uncontrollable spending and unsustainable debt, the government has no choice but to raise taxes, create more regulation (taxes or higher prices to the consumer) or dramatically cut benefits. Any cut in benefits must be perceived as a tax increase (less for the same price).
IS A QUALIFIED PLAN A TAX-SAVING EVENT?
A qualified plan, a 401(k) or IRA, can be a tax-savings event only if you retire to a lower tax bracket than the tax bracket you were in when you deposited the money into the plan. In reality, a qualified plan is a tax-delaying event. It simply delays the tax to a later date and possibly a higher tax table due to government spending, debt and long-term benefits promises.
WOULD YOU CONSIDER YOUR HOME AS AN INVESTMENT?
Let’s examine this question from a different perspective. Is your home equity a good place to keep your money? Can the equity inside your home suffer losses from declining home values? Does making extra payments on your home increase the value of your home? Can you access the value or equity in your home in the event of an emergency or if you become unemployed or disabled? Economic trends and shifts that will impact home ownership will determine what approach should be taken in purchasing a home.
IF GIVEN A CHOICE, WOULD YOU WANT TO PUT YOUR MONEY INTO SOMETHING THAT IS 100% TAXABLE, SOMETIMES TAXABLE OR TAX-FREE?
This question is easy to answer. Everyone would want to avoid taxes if they could. The problem is traditional thinking continues to guide people down a path where they said they don’t want to go. IRAs, 401(k)s, pension plans, stocks, mutual funds, bank saving programs, CDs, annuities, etc. – all create, in many cases, taxable events. Some of these taxable events could be as high as 20%, 30% or 40%. Everyone’s goal should be to create as many tax-free dollars in their future as they can.
WHAT ARE THE TWO GURANTEES IN A QUALIFIED PLAN?
In a typical 401(k) or IRA, there are two guarantees: you are the only one at risk (in the marketplace) and it will be taxed. These two guarantees that you don’t want, but in many cases, you’re stuck with them. You could involve yourself in fixed-return products or a Roth IRA, but fixed returns are a historic low and Roth may still be subject to market risks.
WHEN SHOULD YOU TAKE MONEY OUT OF A QUALIFIED PLAN?
Many people will respond to this question by saying “when I retire” or “when I’m 59 ½, 62, or 65 years old.” Although this is good traditional thinking, I need you to think a layer deeper, (THIS IN NOT A RECOMMEDATION OF ANY KIND. BEFORE MAKING ANY DECISION ABOUT YOUR FINANCIAL FUTURE, SEEK ADVICE FROM AN EDUCATED PROFESSIONAL.) You should take money out of a qualified plan when taxes are at their lowest level. Now ask yourself this question: will taxes be higher or lower in the future? The current tax bracket you’re in right now may be the lowest bracket you will be in for the rest of your life. I’m not telling you to take your money out of qualified plans now; I simply want you to think about the situation you’re currently in and the situation you will be in at retirement.
WHAT IS THE RATE OF RETURN ON THE DOWN PAYMENT ON YOUR HOME?
If you were to put $30,000 down when purchasing a new home, what is the rate of return on that money? It‘s 0%, and it will be 0% forever. Now the bank will argue that your down payment lowered your monthly payment. That may be true on the surface, but let’s take a look at what the bank got out of the deal. At a 7.2% rate of return, that $30,000 down payment would grow to $240,000 in 30 years. That is probably more than you paid for the house. One other thing you should consider is that the down payment is not a tax-deductible event.
WHEN SIGNING UP FOR YOUR QUALIFIED PLAN, DID YOU CHECK THE 30% OR 40% GURANTEED-LOSS BOX?
This is just a question to make you think. There is no question like this on your qualified plan form, but maybe there should be. The day you retire and start thinking about the income from that program; it may be taxed as high as 20%, 30%, or 40% (non-Roth). Remember, it will be taxed regardless of how much money you put in or the amount of risk that you take.
WHEN SIGNING UP FOR YOUR QUALIFIED PLAN, DID YOU CHECK THE 30% OR 40% GURANTEED-LOSS BOX?
This is just a question to make you think. There is no question like this on your qualified plan form, but maybe there should be. The day you retire and start taking income from that program, it may be taxed as high as 20%, 30%, or 40% (non-Roth). Remember, it will be taxed regardless of how much money you put in or the amount that you take.
WHAT IS THE RATE OF RETURN ON THE EQUITY IN YOUR HOME?
The rate of return on the equity you have in your home is 0%. The value of your property will go up or down regardless of whether you have one dollar of equity in your home or $100,000 of equity in your home.
IF I CAN TELL YOU THE EXACT DAY THAT YOUR RETIREMENT ACCOUNT IS GOING TO SUFFER ITS GREATEST LOSS, DO YOU WANT TO KNOW THAT DAY? IF YOU COULD DO SOMETHING NOW TO REDUCE THOSE LOSSES, WOULD YOU DO IT?
You would probably do anything to avoid any losses, but the day you retire and start thinking income from that plan is the day you retire and start taking income from that plan is the day you will experience losses anywhere from 20%, 30% or 40% due to taxes on that income. If you know this problem is confronting you in the future, and have an opportunity to create tax-free dollars in the future, instead of taxable dollars, should you do it? Creating as many tax-free dollars as you can in the future will be the key to your financial success and freedom.
CAN YOU BORROW PART OF THE DOWN PAYMENT YOU PUT ON YOUR HOME IN AN EUQITY LINE OF CREDIT?
No. Your down payment is not part of the mortgage, and you can only access the equity portion of the mortgage…and only if you qualify for the equity line of credit.
IF YOU TAKE MONEY OUT OF A QUALIFIED PLAN PREMATURELY, IS IT YOUR UNDERSTANDING THAT YOU WILL BE TAXED AND PENALIZED FOR TAKING THAT MONEY OUT? IF THAT WERE NOT COMPLETELY TRUE, WHEN WOULD YOU WANT TO KNOW ABOUT IT?
Taking money from a qualified plan prematurely is usually frowned upon for good reasons. Once again, it is not my recommendation to simply take money out of a qualified plan before retirement, but to discuss the traditional thinking surrounding this issue. First of all, if you take money out of a qualified plan prematurely, it will be taxed. Well, the truth is that it will be taxed anyway, sooner or later. Now the penalty part, 10% is real for early withdrawals. It may surprise you to know that Internal Revenue code 72t allows for withdrawals of IRAs, not 401(k)s, prematurely without penalty. There are three distribution methods under this code: life expectancy, amortization or annuitization. The life-expectancy method simply calculates the amount that can be withdrawn annually by dividing your account balance by your life expectancy based on tables furnished by the IRS. The second method is amortization, which allows you to amortize your account balance based on a projection of what your account might ear over your lifetime. The IRS requires that the interest rate assumed in this calculation be “reasonable.” For the annuitization method, the IRS also allows withdrawals based on a life-insurance mortality table (UP-1984) and a reasonable interest-rate assumption. This method normally generates the largest withdrawal. Before using any of these methods, seek the advice of financial professionals.
WHOSE FUTURE ARE YOU FINANCING: YOURS OR THE GOVERNMENT’S?
This question is designed to make you think when it comes to traditional thinking and planning your future. The government, who created and controls the rules in qualified retirement plans, has a vested interest in the growth of these programs, in the form of future taxation. The government’s share of these programs is rather unique. They get as much as 20%, 30%. Or 40% of the amount you have accumulated in these programs in the form of taxes when you start to withdraw the money, regardless of how much you put in the program and the market risks you had to take.
All of these questions are the starting point in establishing a new thought process. Understanding how money works in your life may help in guiding you in making better life decisions. In the past, traditional thinking has told you “What to think” not “how to think.” With more information, you can begin to feed the solution instead of feeding the problem you will be facing in the future.
SUMMARY
YOUR MONEY WILL NEVER BE WORTH MORE THAN IT IS TODAY
Due to inflation, the value of the buying power of a dollar continues to decline year after year. One most also consider that not only is the dollar losing buying power, but also just about every dollar you touch will be taxed, leaving you with even less money.
THIS MAY BE THE LOWEST TAX BRACKET YOU WILL EVER BE IN
With a declining workforce, an aging population and an increasing number of government social programs, the government is involved in uncontrollable spending, unsustainable debt and the uncertainty of surviving as a country. The only solution for the government to survive is to take more control of the economy and to raise taxes and invent new taxes. No matter how you look at it, TAXES are going to increase, putting a strain on the average American financially.
YOU CAN’T DO THE SAME THINGS OVER AND OVER AND EXPECT DIFFERENT RESULTS
People need to concentrate and pay attention. Traditional thinking, what you have been taught and trained to think, may not be serving you well. Average Americans continue to use the traditional programs that reward and pay others first (banks, the government, investment companies etc.), only to find that there is very little left for them in the end. Everyone should attempt to break these cycles (programs) that they are involved in.
LARN WHAT IS TRUE AND WHAT IS NOT TRUE
If something you thought to be true wasn’t true, when would you want to know that? Some of the traditional thinking you have been taught in the past may not be completely true. Some of the most basic concepts in your personal life may have been created to benefit others rather than you. You must also understand that you are being marketed to death by companies who stand to profit from you under the belief that you will benefit from them.
THREE TYPES OF MONEY
Don’t make your thought process about your financial life more complicated than it needs to be. There are only three types of money in your life. Your LIFESTYLE money, your ACCUMULATED money and TRANSFERRED money. How much time do you want to spend decreasing your lifestyle to achieve your future goals? Not very much. Do you really want to spend the money you have already saved for the future? No, you don’t want to do that either. Maybe we should start by reducing the transfers of your wealth that you are unknowingly and unnecessarily giving away. You must learn to identify these transfers in your life and recapture the money you are giving away.
THINGS YOU CAN DO WITH MONEY
Once you have money, what are you going to do with it? Again, this is not a complicated lesson. But you must learn how money flows in your life – how it flows in and how if flows out. Learn what it means to ACCUMULATE, FLATTEN OUT, and SPEND DOWN money.
THERE IS GOOD DEBT – THERE IS BAD DEBT
Debt comes in and out of your life in different ways. There may be times when you want to use someone else’s money (SEM) to do something you want to do in life. There is a big difference between LEVERAGED and UNLEVERAGED debt. One must be careful when it comes to debt – it can ruin your life.
RICH PEOPLE THINK….POOR PEOPLE THINK…
Discover the three rules of the rich. How does their process differ from traditional thinking? Lessons can be learned from those in the highest tax brackets who want to avoid taxes. Apply the rules of the rich to your future plan. Avoiding taxation and risk is the key.
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