The ‘New Normal:’
The Great Financial Enlightenment?
The term ‘enlightenment’ refers to the belief that we are leaving behind the dark ignorance and blind belief that characterized the past.
We can liken the dark ignorance to our lack of understanding of our own finances and our investments. Many of us walk around in blind belief that the taxes coming out of our paycheck are insurance that we will be taken care of when we need it.
Americans have begun to realize the possibility that no one is really watching over our investments, businesses or future like we presumed. This realization has come to us in the form of expensive and tragic lessons. Americans who work hard, pay taxes and diligently put back money for the future are the ones who have been most affected by these trying economic times. As financial professionals, we encourage Americans to investigate the individuals they trust for direction and the investments they consider. Education and transparency will be the main characters starring in the ‘new normal.’
There are many ways to prepare ourselves for current market conditions becoming the ‘new normal.’ It is important that we educate ourselves by asking questions. Knowing the risks your investments, businesses and future have is the first step in protecting yourself. We should all be encouraged to leave behind the dark ignorance and blind beliefs and follow a path of proactive measures and participation.
Some risks we face can be mitigated through proper positioning. Softening the blow of inflation, increasing tax liability and risk of longevity is not an easy feat for the average investor. Here are a few ways to help reduce those risks, or rather specific questions to pose to your CPA or financial professional.
Risk of inflation: The Silent Killer‑This risk to your livelihood at retirement is the most overlooked and disregarded factor in planning for your future. It creeps up on you, and its risks do NOT single out retirees.
- EXAMPLE: My son was born in 1997. If I put $100,000 in a saving account that earned 0% from 1997 to today, that $100,000 would only have the purchasing power of $73,585. That is a 26.41% increase in the cost of groceries since he was born! My daughter was born in 2004. Her princess dresses cost 14.40% more today than the first one I bought! Here is a terrifying thought … Our nail polish costs 82.7% more than what we paid in 1970. What is it going to cost when we are 90 years old?
Ask your insurance agent about inflation riders available on your insurance policies. It may increase the premium you are paying, but an analysis will allow you to make an educated decision on whether or not it is worth the extra premium.
Choosing investments that can mitigate your risk of inflation is another option. There are too many investment vehicles that have their own special caveats to mention here, but make sure you are asking your financial professional what their solution to inflation risk is.
Risk of increasing tax liability: If I were to ask an auditorium full of American taxpayers to stand if they think taxes will be lower at their retirement, less than two people would stand. If you retire with $1,000,000 in your 401(k), it would be worth only $680,000 today. If taxes continue to increase, the real value of your 401(k) decreases … and you see the point. The government is allowing the working class a tax strategy called a Roth conversion without limitation. You may convert qualified funds to Roth IRA in 2010. There are no dollar amount restrictions and no income restrictions. The benefit to taking advantage of this rare offer is that when you take distribution, the money is income tax free!
- EXAMPLE: You have $50,000 in a 401(k). Convert to a Roth and pay the taxes due. (A CPA will need to advise you of the taxes due). Let’s say you are in a 25% Federal Tax Bracket and 7% in your state tax bracket. In this example, taxes due are $16,000. You can pay $8,000 in 2011 and the remaining $8,000 in 2012.
The benefit is your money continues to grow tax deferred. When you take distribution 15 years from now, taxes could be at a 50% rate; however, your Roth money is income tax free! That means having $1,000,000 in a Roth IRA is actually $1,000,000! Pretty good deal! As long as your CPA gives you the green light …
Risk of Longevity: Most of us strive for longevity and the Fountain of Youth. We see longevity as a positive occurrence that is a reflection of our good health. So, why is longevity considered a risk? Not planning for a longer life can result in retirees having to return to the workforce and/or depending on family members for financial support. According to IRS tables, the average 50-year-old today will live to be age 84. The same IRS table also shows that the average 84-year-old today will live past the age of 92. Considering investments or income strategies that provide income for life will reduce longevity risk dramatically.
In summary, it is our hope and prediction that Americans will come out of this crisis more educated, having higher expectations of transparency from both governmental agencies that spend our money and corporations that we trust to grow our money. As a result, we will be able to effectively reduce our risks of inflation, increasing tax liability and longevity. In this era of financial enlightenment, our investments, businesses and future will not have exponential growth followed by devastating bubble bursts, but rather consistent, measured conservative increases to carry us to our last days.