Friday, December 4, 2009
The problem is that tax increases es are being labeled as going on "the rich." First of all, who are "the rich?" I think we have a concept of robber barons of the 19th century, or industrial capitalists, like Andrew Carnegie, or maybe Wall Street "fat cats". So we just see the label don't think through what's going on, since after all, we don't fit our own preconceptions of "the rich."
Reality is that many of these new taxes and tax increases actually hit everyone. Or many people. It is imperative to do everything in your power to reduce your tax liability.
Number one: retirement savings. If you have a tax rate of 30%, you get an immediate return of 30% (plus the annual rate of return of the investment) on your initial investment. So you put $1000 into a retirement account. You get your $1000, plus you've saved 30%, or $300, on taxes. Even if you put your money into a fixed annuity that's paying 3%, you've got a first year net gain of 33% or $330.
If you are a business owner, you should also be funding a Keogh Plan. Business owners can shelter or $49,000 of their income (which ever is smaller) in a Keogh retirement plan. Going back to the example of a 30% tax rate, the business owner saves $14,700 in taxes plus gets $1,470 in interest, gaining $16,170 the first year.
Look at it this way: if you are a business owner and have the choice of buying a new car for personal use or funding a Keogh Plan, if you buy the car, you've just paid 30% more than it's list price because you can't take the cost of the car off of your taxes. Likewise, if you have a choice between funding your IRA this year or going on a really nice vacation, and you take the vacation, well that has just cost you 30% more than what you paid for it.
Thursday, August 6, 2009
More importantly, I believe this quote can be modified to reflect the importance of economic responsibility: "A person who won't save has no advantage over one who can't save."
Think about it. Just a reading enlarges your knowledge, and gives you more perspective on life, saving enlarges your options and gives you more ability to handle what life brings. Why don't people save more? Maybe it's the same reasons why they don't read more: it takes a bit of discipline, effort, focus, and life style.
And, just like I can't make someone want to read, once someone does, they can quickly see the value in the activity, and develop a desire to read. Same with economic responsibility.
We have to start somewhere. What do you spend money on that is just discretionary? It's the small things that start a habit. Going back to reading. How do I find time? I keep a book in my car. With traffic here in Northern Virginia, I always leave early in case there's a tie up. When there's not, and I get to my appointment early, I will read--in the car, in the office I'm going to, find a Starbucks close by. Fifteen minutes here, fifteen minutes there adds up after a while.
Same with savings. What little pieces of discretionary spending can you refocus to savings? That drink you buy every time you fill up? The afternoon snack you get in the vending machine? The drink you stop in for after work? When you start seeing your focus start paying off, it creates a desire for more.
The point is this: some people can't save. They may be disabled, intellectually limited, or so burdened by the financial responsibility for others that savings isn't an option. It's hard and desperate. For you and I, it's a matter willingness. To rephrase Mark Twain one more time: "A person who won't save has no advantage over one who can't save."
Tuesday, July 28, 2009
Well, it depends on the consequences. For instance, in firearms training, students are taught to be extremely cautious and responsible, as the consequences of mishandling a firearm can be, and often are, deadly.
To answer the question "How much responsibility is enough?” we have to understand what the consequences are of not being economically responsible.
What do we know about life? We know that it rarely goes as planned. We know that not everyone lives to an advanced age. We know we can't really predict the future. We don't know what the driver in the next lane or the next mile is or will be doing. We don't know if our company will get bought out. We don't know if our knowledge or functionality will become obsolete. We don’t know if there is a stray virus hanging around somewhere. We do know there is so much out there that is out of our control.
We know that bad things happen to good people.
So, the consequence of not being prepared, of not living economically responsible, has high consequences at times. Not everyone will die early and suddenly. Not everyone will become disabled. Not everyone will loose a job. But, like the consequences of mishandling a firearm, when these things happen, and they do happen, the consequences can be devastating.
In light of the nature of life, it makes sense to create a minimum level of precaution. I love that word, precaution. It's "pre-" and "caution:” being careful ahead of time. The time to be cautious when handling a loaded gun is before it goes off, not afterward! The time to put mechanisms in place to handle the crises that are an inherent part of life is before they have a chance to happen, not afterward.
At a minimum, it's my opinion that everyone who has people depending on his or her paycheck out to have enough life insurance so that the survivors can live indefinitely with out having to touch the principle. Or at least enough income for the dependent children to grow up. And, since people can loose jobs, it makes sense to have 6 months worth of income socked away too.
Overly cautious? It depends on if you're going to be one of the people who won't make it to old age, or looses a job. We just don't know. We just don't know when that firearm might discharge.
There are other precautions--being careful ahead of time--which I think are important: no consumer debt. No credit cards. No car loans. I know, not everyone is willing to do that. It's inconvenient and gets in the way of our desires. We all have a long "want list." I want a new car. I want a nice vacation this year. I want a new set of clothes. I want to eat out at a nice restaurant. Funny how those wants fade into insignificance when life gets tough.
Bottom line: the consequences of mishandling life can be tremendously painful and devastating. Being careful before you have to be creates a powerful safety net that is not wasted and, if needed, is indispensable.
Thursday, July 16, 2009
Anyhow, maybe my cliche's are a bit dated, but the focus of keeping more of your money in the face of big government spending is very timely. The latest cost for the universal health care bills in Congress is $1,500,000,000,000. That's $1.5 Trillion. And that only goes out 10 years. Add on top of the "bailout spending in the past year at 3.5 Trillion (http://forums.qrz.com/showthread.php?t=182335 referencing www.bailoutsleuth.com) and we are talking about more than a third of the GDP.
The money has to come from somewhere. That means taxes, levies, and fees. And with the battle in congress indicating that "everything's on the table" (it was a sound bite of one of the politicians who was being interviewed), I take that to mean that the every source of revenue that is politically acceptable will be looked at to fund these expenditures.
The signals to me can't me any clearer. The time to lay the ground work for sheltering our income from the needed tax increases is now. You will need time to plan and execute a strategy. You will need time to meet with your tax advisor or accountant. If you and I wait until taxes are higher to start, it will already be too late.
What am I doing? Well, as a business owner, I am taking advantage of the IRS rules that allow me to have a Keogh plan, sheltering up to $49,000 of income from taxes. I also have an IRA, and a deferred annuity.
Since I need life insurance anyhow, I have a return of premium policy, also called a "cashback" policy. Sure, I'm paying almost twice what a regular term policy is. But if I bought just a term policy and invested the difference, I would have to get about 7.8% interest tax free. That's just not likely in this environment. I will get back all my premiums (if I'm lucky enough to live to the end of the term) and won't pay taxes on that since it will be considered a return of my own money and not capital gains or interest.
The bottom line for me: spend less, shelter more. Think about it like this: if I can shelter $1000 from taxes, and I'm in a 33% tax bracket, I automatically have made 33% on my money (because I'm avoiding $330 in taxes). To me, that's economically responsible.
Tuesday, July 14, 2009
During our discussion, Ms. Christianson shared with me a surprising statistic: more than 85% of non-profits have an annual revenues of $1,000,000 or less. But then when I thought about it, most of the non-profits I've been involved with fall into this category. And probably most U.S. businesses have annual revenues of less than a million too, since most US businesses are small businesses.
Of course, Ms. Christianson's practice is to assist the non-profits get the most out of their operating funds. Look at it this way: if she can get a $20,000 efficiency out of the operations of a $500,000 annual budget, she has just effected a 4% increase in available funds. That's economic responsibility: using what we have for better results.
Of course, I operate on the supply side. On of my favorite seminars is on Charitable Giving. Without expectation, I have helped host charities increase their revenues by showing individuals how to use the tax code to subsidize their gifts at 100% to their estates.
The bottom line for me: non-profits are a critical element in our society. They perform a service that government or single individuals can't do or can't do well. They are formed and staffed by people who are passionate about what they do. We need them and their work. Helping them more fully achieve their mission is part of what it means to me to be "economically responsible."
Thursday, July 9, 2009
Dan owned a paving company. He started it 35 years ago with a used dump truck, a used paver, and an old steamroller he bought at an auction. Now, he has 15 dump trucks, four pavers, six flat beds, three graders, a couple front-end loaders and a half a dozen pick ups, and some other miscellaneous equipment. His three sons in their 20’s work in the business. His wife died of a heart attack three years ago. Dan is 56 and is making plans to pass on the business to his sons.
His attorney and accountant valued the business at $9,500,000—assets minus liabilities. Dan was shocked to learn that the estate tax bill would be something like $5,500,000 if he were to die before his sons owned it. He and his attorney put together a plan so that the three sons would be equal 30% owners in 10 more years. Dan wanted to keep 10%. His concern was “What if he died prematurely like his wife did?” The son’s would be hit with a huge tax liability. Maybe they could borrow the money and pay it back over 10 or 15 years. If so, the total cost would be around $8,000,000, maybe more. Maybe the IRS would let them pay it back over time, at 6% interest. Again, we’re talking millions of dollars.
If they couldn’t do either, they would have to sell the business. In such a time, they would have to get out of it what they could, and it wouldn’t be close to the full retail figure. Again, millions of dollars lost.
That’s when he called me. We put together a 10-year term policy for $6,000,000. Why the extra $500,000? The sons weren’t in a position to run the company themselves at the present. So Dan wanted extra money to hire a COO while his sons made the transition to business owner. It was all spelled out in the transfer documents drawn up by the attorney.
What did such a huge policy cost Dan? Would you believe $19,900 a year? That may sound like a lot, but remember we’re talking millions of dollars that are at risk as an alternative. As Dan said, “That’s not even the cost of a pick up truck.”
So, in 10 years, Dan will pay out a total of $199,000 in premium to protect his business from more than $5,000,000 in estate taxes. He is paying that to protect his legacy, and provide a lifetime of income for his children, and he hopes his children’s children. As he said, “That’s not even the cost of a couple dump trucks. That's well worth the cost of making sure I can pass intact what took me my whole like to build to my three sons and their children.”
To his credit, he paved the way for a smooth business transition.
Wednesday, July 8, 2009
It had been 5 years since I had seen a former coworker, Jen. She was in her mid-30’s when she left the company I was working at, and had started a pizza restaurant with a family friend who was 15 years her senior. He owned 51%, she 49%. Now, Jen looked like she was in her 50’s. I asked her how her restaurant was. I knew it was next to the campus of a big university—25,000 students. “Busy,” she said. “Too busy.”
“Great!” I said. It must be nice to have a place that is so successful.
“Not really,” she said. Then she explained. Her partner had a heart attack and died 2 years before. He was the kitchen manager. She was the business manager. Now she had to do it all, and was working 70 and 80-hour weeks.
“Why don’t you just hire someone to be the kitchen manager?” I asked.
“I can’t,” she said. “I don’t have enough funds.”
“Wait a minute. I thought you said the restaurant was doing very well.”
“It is. But Joe was married, and his wife is now my partner. She’s not doing any of the work, and expects half of the profits. She got a lawyer, and I fought it in court for a while, but I’m stuck with her. So I’m doing my job, Joe’s job, or now his wife’s, and I’m only getting half the profit. I’m stuck.”
This encounter with a former coworker demonstrates a common example of the often-ignored need for business continuity planning. People go into business because they’re good at something, and don’t’ think to make plans for the business to survive them or their partners. And they end up in a bad situation.
Facts are, businesses represent the major asset for business owners and their families. Jen had put a lot of money into the business, as had Joe. It was her only source of income. It represented her largest asset as well. Furthermore, I guess I couldn’t blame Joe’s wife for wanting to hang onto the business. She essentially had no job skills, and the restaurant was her meal ticket. She was entitled as Joe’s survivor. But the lack of a plan left Jen in a world of hurt.
What were Jen’s options at this point? She could just walk away, but she would be liable for half of the businesses debts. This would cost Jen hundreds of thousand of dollars.
The business could be sold. Jen wouldn’t get nearly what she had invested for the restaurant equipment. I don’t know how she would have fared on the sale of the commercial space. But it could have taken a lot of time to sell it. Plus there’s the cost: broker’s fees, etc. There might even be a legal dispute between her and Joe’s wife. Besides, she was now the majority shareholder, which left Jen in a vulnerable position. So again, this decision might cost Jen tens or hundreds of thousand of dollars.
A third option would be for Jen and Joe’s wife to come to terms of a buy out agreement. Then Jen might be able to borrow the money to pay her new partner off. But again, it’s a long a complicated process to properly evaluate a business and complete the sales process. This process costs thousands of dollars and takes time. What would happen to the profitability of the business while Jen and Joe’s wife and fighting over that? Would there be much left to run? Furthermore, the cost of borrowing the money for the buy out would be substantial. Tens of thousands in interest. And even after that happened, Jen would not be in a position to hire a kitchen manager. She would have the additional overhead of the loan to service. She would have to run the whole show herself for some time afterward.
Jen had no good options. None that weren’t very costly either.
I didn’t go into the “why didn’t you” mode with her. It was water over the dam. But I was thinking it. A business continuity plan, and life insurance on each partner, would have been by far the cheapest and most effective solution, had Jen and Joe done it when they started the partnership and the business.
Here’s how it could have worked. Jen and Joe start the business, and each buys a life policy on the other, in the amount that represents their share of the value of the business. Say the business is worth $750.000. Jen would buy a life policy on Joe for $382,500. Joe would buy one on Jen for $367,500. That way, if the other dies, the survivor would buy out the survivor’s beneficiaries with the proceeds. Of course, this would have to have what’s called a “Buy-Sell” agreement in place too. The other thing is that both Jen and Joe would need to re-evaluate the value of their business regularly to keep the agreed to purchase price current.
The cost for all this? When I ran illustrations for a “What If” scenario, I came up with $529.00 for Jen and $1604.00 for Joe at the age they were when they started the business. That’s a little over $2100.00 a year.
Clearly, life insurance to fund business continuity plans is always the least expensive option financially. And, as we can see from this case, it is also the least expensive emotionally.
If it were easy being in business, everyone would do it. However, small business is the backbone of our economy. I’ve read statistics from the US Department of Labor that more people are employed in small businesses than all the Fortune 500 businesses combined. I’ve also read that small businesses contribute more to the GDP than all the Fortune 500 companies.
So small business isn’t so small. Not for the business owner. Not for our economy.
It’s a puzzle, then, why so many small business owners don’t plan for their businesses to out live them. In an informal survey, I asked 50 business owners what their business continuity plans were. A full 45 didn’t even know what that was. The other five thought I was talking about disaster planning.
The survivors, which would include partners if there were any, of a business owner only have 3 basic choices when there is a lack of business continuity planning.
1. Liquidate the business. This is probably the most expensive option, literally costing hundreds of thousands if not millions of dollars. Those who have a financial stake in the operations loose all the future income from the business. They are also giving up much of the business’s present value.
2. Take over the business operations. One of the problems with this is that if the survivors were suited to be in the business, they would have been the business owner and not sitting on the sidelines. I’ve seen several family owned businesses run into the ground this way. This is a costly option, not only in losss of future income, and reduction in present value, but also in terms of emotional stress. If the survivors hire someone to take over the functionality of the business owner, there is the cost of that person’s salary. They probably won’t work for the same salary as the business owner. Cash flow can be a big problem here. Often times, borrowing funds is necessary, if they can be found. This adds to the expense of taking over the business.
3. Sell the business. The problem here is that it can take a long time to sell a business at full price. So to affect a quick sale, the business and its assets are often sold at a discount. Again, this is very costly, in the hundreds of thousand to even millions of dollars.
The least expensive method—by far-- of ensuring business continuity is to provide insurance on the life of the business owner(s). It comes out to less than a penny on the dollar to the other options.
Tuesday, June 30, 2009
1. This strategy immediately replaces the value of the hard asset in the individual’s estate. In many cases the value of the life policy is higher than the net sale price of the asset.
2. This strategy allows individuals to support their favorite non-profit without reducing the value of their estate.
3. All income tax brackets can benefit. Higher brackets realize higher returns.
4. This strategy is best used by individuals who do not need the proceeds from a hard asset for immediate income.
5. This strategy is best used for individuals who do not need the tax savings achieved through charitable donation for immediate income.
6. This strategy is often better suited for providing future income than is possible through retaining the hard asset.
7. This strategy avoids all of the costs associated with retaining a hard asset: taxes, insurance, maintenance, etc.
8. This strategy avoids the costs of selling the hard asset, which can be quite substantial.
9. This strategy is effective at turning a depreciating asset into an appreciating one.
10. Changes in the Federal Tax Code may reduce some of the benefit of this strategy, so it is better to act on it in 2009 than waiting.
We've seen the income of non-profits decline as the economy worsens. This article show non-profits how to increase the member's donations using the subsidies created by state and federal tax breaks. Many people have a tangible or 'hard' asset they do not need or want, nor do they need the money they could get from the sale of that hard asset. This article shows how individuals and non-profits have benefited from donating that hard asset to a non-profit and were able to fully replace its value in their estates. These strategies have increased giving to non-profits. The case studies and comments in the blog do not constitute tax advice.
Donation of Real Estate
A 56-year-old Fairfax woman inherited her family home upon her mother’s death. Located in rural SW VA, the home was worth $118,000. The home needed interior and exterior painting, a new roof, a good cleaning, and a host of minor repairs to make it ready for sale. Total estimated cost: $23,000. She would also need to pay brokers fees of 6% to sell the home, another $7,080. She would need to continue the insurance on the home, $855; pay the real estate taxes, $185; and pay someone to mow the lawn and keep the place neat and ready for showing, 250/month X 4 months (average time on market) equals $1,000. Her broker also told her it’s customary for the seller to pay 2% to 3% of the closing costs. Assuming a minimum down payment of 3.5% from the buyer, her share of the closing costs (2%) would be $2,277.40. Total selling costs: $34,397.40 or 29% of the retail price, leaving her a net of $83602.60.
The Woman is an attorney in private practice; her husband is an attorney with the Federal government. Their combined tax bracket (state and federal) is 43%. If she donated this property, she would realize a tax reduction of $59,740, just $24,000 less than if she were to sell it. The woman does not need the income from either the sale of the property or the tax deduction. She and her husband are making plenty now and are able to put money aside for retirement. However, she doesn’t’ want to diminish the value of her estate, which would happen if she sold the house ($34,397 reduction) or just took the tax deduction ($58,260 reduction in value of her estate).
Solution: She donated the house to her mother’s church and used her tax savings ($59,740) to purchase a single premium whole life policy. This policy added $158,677 to the value of her estate through its death benefit, or $75,075 more than the net proceeds of the home (47% more). In addition, the policy quickly grows cash value that she can access at no cost in her retirement years if she wants. This would be better than taking out a home equity loan since she won’t pay interest on cash she borrows from the policy.
Added benefit: She donated the home to her parents’ church. They were married in this church, she was baptized in the church, and her parents are buried in the church’s cemetery. Being a charity, the church won’t pay tax on the property. There are no broker fees involved in the transfer. Moreover, the church has plenty of volunteers to fix up the home. They could sell the property if they wanted to, rent it, or use it for one of their ministries.
Donation of a Vehicle
A retired-military 59-year-old man had a Class A motor home that he purchased used 2 years ago. After touring the US and Canada for a couple years, the man wanted to sell the vehicle. Given the cost of gas and the state of the economy, the only interested buyers were dealers, and they were only interested in giving him $31,000 or 43% of its list price of $72,000. The man did not want to take a $41,000 loss. Neither did he want to hold onto it with the hope the market would someday rebound, as the vehicle is a depreciating asset, losing about 15% of its value every year.
Solution: The man is a member of a church that sponsors an evangelist couple who do revivals around the country. He gets a 32% deduction (his combined tax bracket) on the full retail price of the vehicle, or $23,040. He purchased a single premium whole life policy, face value of $42,282, $11,282 more than he could sell the vehicle for. He also converted the asset from a depreciating asset to an appreciating one. And he can borrow from the policy at no interest in the future if he wants to.
Added Benefit: The evangelist couple gets use of a relatively newer vehicle for their ministry, a far cry for the ancient motor home they were using. There will be less cost in operations, due to the better condition of the vehicle. The vehicle also provided increased feeling of esteem in the couple, and also creditability in the congregations that they visited.
Donation of a Car
A 36-year-old woman is a regional sales manager at a pharmaceutical company. She drives over 30,000 miles a year in a car bought by her company and given to her for her business use.. She gets a new car every 3 years. Only the residual value of the car is taxable to her. She just got a new Chevy Impala in March. She has a 2006 Impala LS to get rid of. Her tax liability on that vehicle is 36% of $7440, or $2678.40. This means if she sold the vehicle, she would net $4,761.60 after taxes.
She donated the car to a social ministry who fixes cars up for low-income families. She buys a single premium whole life policy with her tax savings, face value of $6,783.00, or 42% more than what she would net if she sold the vehicle. She adds that amount to the value of her estate. Plus she turned a depreciating asset into an appreciating one. And she can borrow from the cash value of the policy at no cost in the future.
Her church gets a nice vehicle to fix and let a low-income family use so the breadwinner can stay employed, keeping another family off the welfare roles.
Donation of other tangible assets
A 42-year-old woman has relatively new and expensive medical equipment after the death of her handicapped daughter. The items include: an oxygen generator; an “air bed” hospital bed to prevent bedsores; a motorized custom wheel chair; a special lounge chair; a transfer hoist to lift her daughter from her chair to her bed, or from her chair to the bath; various physical therapy and resistance equipment for muscle tone and improved functioning. A used durable medical equipment (DME) dealer is willing to give her $4500 for all of it. She finds out the full retail value of the equipment, if cleaned and reconditioned, is about $21,500. The equipment was bought and paid for by the insurance company of the driver who injured her daughter.
The woman and her husband are in a 32% tax bracket. She donated the equipment to a non-profit that cleans and reconditions it, and gives it to low income people to use. She gets a $6880 tax break—itself $2,380 more than if she sold the equipment to the DME dealer. She bought a $25,303 life policy. The face value of the policy is $20,803 more than if she sold the equipment to the dealer. Plus she has increased the value of her own estate by more than $25,000.
The mother gets the emotional benefit of assisting others who are like her daughter. She adds much more than the sales value of the equipment to her estate. And she can borrow the cash value of this policy in the future at no cost.
Note: The examples are actual cases written by Richard B. Osmann, Ed.D., General Agent for Kansas City Life. 540-353-7913
Thursday, March 26, 2009
Let me explain through a case one of my agents is working on.
The husband of the couple is in his late 40's, and is an attorney in a department of the federal government. His wife is a foreign national in her early 30's. She used to work part time. However, they just had a baby and now she will be home full time taking care of the house and child. The wife spoke to the agent about getting a life policy on herself and on her husband, since they have additional responsibilities with a new baby.
When the agent met with the couple, the husband balked at additional insurance on himself. He explained that he had a group policy for half his annual salary that he got for free through his work, and he didn't see any need in purchasing additional insurance, stating "that amount will just have to be enough." Furthermore, he didn't want to fork out any premium for a policy on his wife, stating "if something happens to her, I'll just give the baby to my parent to raise."
Now, you and I can throw around stereotypes about attorneys, or older American men marrying younger women from developing countries. But the reality is, no matter who the husband and wife are or where they came from, this husband wasn't willing to be fully responsible to his wife and child. The only help he was willing to give his young wife and new mother was a policy he got for free.
I don't know how much an attorney in a department of the Federal government makes. I know he's been in his position for more than 15 years. And knowing the GS levels, I'm figuring $120,000 to $140,000. So we know that cash flow is not an issue. In fact, I learned from the agent that the husband has a gym membership at one of the most expensive facilities in the area, drives an expensive foreign car, and regularly enjoys dining out a very nice restaurants.
It's sad that the wife left the meeting feeling very badly that her husband wasn't willing to shoulder what is a discretionary amount of money to be economically responsible to the two people who love and depend on him the most. In fact, the wife told the agent, "If something happens to him, I will just have to move back to my country. I can stretch the policy he has at work if I do that." Of course, living in a "third world" country with it's lack of economic opportunity, education, and health care wouldn't be a good thing for the child or mother, but that was the only viable option this young mother felt like she had. And more importantly, the only viable option the husband was allowing.
This is only an extreme example in the fact that the wife would move back to a third world country if the husband were to die. Sadly, the dynamic is not uncommon at all. We have cases, on a weekly basis, where one spouse won't give up pleasure based expenses, such as a motorcycle, ATV, boat, playing poker with friends, etc. to be economically responsible for his family.
The fact that the consequences of not enough insurance are so extreme illustrates a point in stark contrast: economic responsibility is really about taking care of your own life and the lives of those who depend on you.
So, how are you being responsible to those who depend on you? Or not?
Wednesday, March 25, 2009
The comfort of Twain's remark is that we have been through economic crises before. Hype is nothing new. People with money have been given empty promises way before you or I were even a thought. Scammers promised high returns on money since there was some one to speak to. Investment schemes have gone bad over the decades. Our country has seen the end of many good times and the start of many tough times. People before have lived through it all. That's what's comforting.
Twain in fact experienced some dire financial times in his life. Perhaps this quote is born from some hard won lessons on his part. Whatever their source, Twain's remarks remind us of what is important in economic responsibility: preservation of capital first, growth second.
We can find many sources of inspiration and often they come from the 'non-financial' sector. Someone with as much life experience and perspective as Mark Twain can shine a common sense light on what means to be economically responsible.
Tuesday, March 24, 2009
So what does this quote mean? Well, it means two things to me.
First, we've heard people say "I'm waiting for my ship to come in." That's kind of a passive way to approach life. Just sitting around waiting. We know lots of people like that. Their idea of initiative is to sit around. OK, maybe they'll buy a lottery ticket once in a while. But they see economic success as just something that happens to them without their initiative and without their control.
The second thing I pick up from this quote is that while desire and effort are important, equipping, planning, and good execution is critical to financial success.
It's not enough to want success. You have to want it enough to risk your comfortable and predictable spot on the dock. You have to want it enough to be willing to get in water. You have to want it enough to perhaps learn to swim, to train so you can swim better and longer, and to pick a good day to do it. You have to want it enough to have a good safety net or plan, so that if things don't go right, you can try again and not drown in the middle of your first attempt.
Let's face it, for most people, financial success is something we have to go out and get. So, to my fellow swimmers: let's train, make sure we pick the right times to make our attempts, and have our safety plans in place.
Being active, intentional, and deliberate--those are key parts of economic responsibility.
See you in the water!
Let me repeat something I mentioned in a previious this blog--this is not a policital soap box. Having made that disclaimer again, our elected policticians have their shorts in a twist at the bonuses paid to several dozen company executives, at the cost of a few hundred millions dollars. Has anyone missed the contradiction (some may call it hypocritical) that only a week before, the president signed a spending bill that I understand had over 8,000 ear-marks (pet spending projects put in there by both democratic and republican legistators to benefit businesses in their districts) that cost billions. And this bill was signed after a campaign that promised no ear-mark spending, also called "pork barrel"? I like the term "pork barrel" better--it's more descriptive of the purpose of this use of yours and my dollars--spending our money for their for political purposes.
The reality is no one is in a position to be as economically responsible with your money as you are. You earned it. You and your family depend on it now and in the future. They are your first priority. You have a critical interest in seeing that you keep more of what you earn, that your savings are safe, and that you and your family have a better tomorrow than yesterday.
What is the saying? "Charity starts at home"? We can change that to say "economic responsibility starts at home". And, if the blogs on this site peak your interest, give me a call so we can discuss your situation.
Monday, March 23, 2009
That's the same type of ill-conceived advice I've heard from pundits who say that spending is the way out of this economic crisis. Let's do more of what got us into this mess! Have another round of debt! As a country, we've been binging for a long time. If we haven't been buying ever more expensive homes, we've been taking out home equity loans on the increased "value" of the residence we're in to fund "life style" expenses: vacations and trips, new cars, etc. It's all fun and games until someone gets hurt.
Maybe there does need to be more spending in the national economy. I don't operate on that level. I'm interested in my own personal economy. And your own personal economy. Is that the right thing for you to do--spend more, and more, and more?
I never thought it made sense to spend to the limit of your income. There is nothing like knowing you can turn to a nice nest egg when times are tough. And I'm not talking about the equity in my home, either. As we have seen from the recent real estate market, the value of an illiquid asset shrinks with demand. Nope, I'm talking about liquid and safe instruments that can be tapped when and if needed.
Funny thing about saving more--we have more power and control over our circumstances. This is true, I think, both individuall and as a society. If we can have 6 months of very liquid investments, we could weather getting laid off a lot better. When we as a society save more, then the banks would have more cash, and wouldn't need (as much of) a bail out. Maybe it's simplistic, but it makes sense to me.
Economic Responsibility to me means always living well with in your means. As a person. A family. A society. We can't help what the greater society does. It's habits are shaped by advertising and business interests that have a vested interest in their own income, not ours.
But we can follow through on economic responsibility with ourselves and our own families.
Well, ABC News recently published an article on line that identified some creative ways government is trying to raise cash flow [http://abcnews.go.com/Business/Economy/story?id=7135684&page=1]. The title of their online article is "You Want to Tax What? Government Gets Desperate".
Admittedly, this article describes what I call "fringe taxes": levies that hit only a part of the population. Mostly "sin" taxes. It's an interesting article. But it's just the beginning, I think. The reality is these taxes and fees can't raise enough money to be of great significance. But, they do get the population used to more expense, I believe.
Look--the government is likely to be first at the trough to eat. Their share comes off the top, what ever size they determine that share needs to be. Soon, I think, we will see proposals for broader taxes and reductions in exemptions to make the current taxes apply to more people.
Fore-warned is fore-armed. Sheltering your estate from a higher "death tax" through insurance, creating tax deferred wealth through annuities, sheltering cash in cash-value policies are just three very legal and common ways to keep more of what you have worked so hard to accumulate. It's the economically responsible thing to do.
Thursday, March 19, 2009
But that's not the pitiful part. This week I found myself in that situation. I was in a rural area and stopped at the first convenience store I came to when the addiction struck. When I went to the cashier to pay for the drink, there was a large plastic jar on the counter with pennies, nickles, dimes, some quarters, and a few dollar bills in it. A sign on the jar said "Help us help the Johnston family." Below this headline was the picture of a seemingly healthy man, looked to be in his early-30's holding a small child, and both were smiling. Below the picture, the text informed me that Mr. Johnston died unexpectedly and left a wife and 2 kids. The collection jar was placed there by his church to help the family. I asked the clerk if she knew the family, and she said she did. She said Mr. Johnston had no life insurance when he died.
What's pitiful is that this family's never going to be whole again. I'm not talking about the emotional void the family has. Nothing can fill that. Rather it's the economic desperation they're going through. Hats off to his church. They are doing what they can to help. (I found out the church had placed jars like this all over the area). But look at the reality. There might have been $25.00 in the jar, tops. And the jar had been there for 3 weeks. So let's say there were 40 of these jars total with a similar amount of collections. That's still only $1000. Hardly enough to sustain the family for any length of time.
The cashier told me Mr. Johnston came "in all the time." In the mornings, he would stop in for a coffee on his way to work. In the afternoon, he usually stopped for a snack and a drink on his way home. He filleds his tank a couple times a week. The cashier told me that money was tight for the family, as Mr. Johnston was the sole "breadwinner". Clearly this cashier was feeling bad about what happened to a community neighbor and good customer, and helpless to do anything more significant to help the family.
I dropped my 41 cents in the jar. (The drink was $1.59 including tax). And on the way out, I thought, "You know, this guy probably spent $5.00 a day on drinks and snacks at the convenience store. That's a hundred a month. For a young 30-ish man, that buys a damn nice life insurance policy." After I got back to the office, I ran an illustration for a 35 year old standard health non-smoker and found that this guy's snack money would buy a $844,835 term policy for 20 years.
You can tell this situation made me angry. All I could think of was the desperation his wife might be feeling right now. How often does she wake up at night, not because she's missing her husband, but because she's worried about how she'll make the rent or mortgage--if not this month, then the next? Or how many bills are piling up on her kitchen table? Does she worry about getting her growing kids new shoes or clothes when they need them? Is she able to go grocery shopping without using food stamps?
I'm sure Mr. Johnston thought he was taking care of his family. I could see from the picture he was a very proud father. And no one expects to die prematurely. But he did, and his wife and her little children are in a world of hopelessness that they can't easily get out of. And all they have now to help them are the good intentions of some good willed people and a pitiful few dollars in collection jars scattered around their county.
Reality is that money feels "tight" for most families. We all have a habit of living up to the level of our incomes. And maybe even a bit beyond it at times. But like Mr. Johnston, we usually have discretionary spending somewhere, even if it's only a few dollars a day. And that small amount applied to a life policy will leave our families a lot more than memories if we take an early and unexpected exit from this life.
Well, Time Magazine recently came out with a feature piece "10 Ideas Changing the World Right Now." The first idea is that "Jobs Are The New Assets"
[http://www.time.com/time/specials/packages/article/0,28804,1884779_1884782_1884749,00.html?xid=rss-topstories]. The reason Time identifies "jobs as the new assets" is because they provide through their income stream, as they always have, the primary means of economic support for today and also the means to economic advancement and wealth creation for most people.
I mention this so you know my posts are backed by sound facts and ideas, and are not the rants of an insurance crazed professional!
Seriously, for Time magazine to label jobs as the "Number 1" world changer is very significant. When the value of everything else is in question, our jobs continue to provide cash flow to our families. A critical part of 'economic responsibility' is to treat our jobs as the assets they are, and be deliberate about our career paths, acquired knowledge, and the acquistion of additional knowledge. This helps promote future income growth for you and your family. Of course, insuring your income stream to your family in case the worst were to happen is so critical as well. This protects them now and in the future, so the plans they have--stay in the house, send the kids to college, retire at a decent age--can still happen whether you are around or not. This treats your income as the premier asset that it is.
Tuesday, March 17, 2009
Stanley Bing, author and columnist for Fortune Magazine, echoes these thoughts. "Look. Throughout the course of human history, life on earth has been a struggle, a disappointment to most, a tragedy to some, a triumph to a few. But for most of us, the small things in life make it worthwhile" [Stanley Bing, Fortune magazine, July 21, 2008]. Of course, the small things are not so small. Seeing your child take her first steps. Or graduate from college. Chaperoning your young teen on his first "date." Taking time to enjoy a simple home-cooked meal with the family. Playing catch in the back yard. Enjoying an afternoon at the museum.
Nothing replaces these times and experiences. No amount of money in the world. But money can help make them happen. And lack of it can prevent them. A father may not live to see his youngest daughter graduate college, but enough life insurance can make it possible that she will graduate instead of having to drop out due to lack of funds. It makes it possible for a surviving spouse and children to take time to enjoy a home cooked meal, instead of the spouse having to work two jobs to support the family.
This is what economic responsibility boils down to for me: making sure that priceless experiences can still happen for those you love, whether you are around or not.
Most small business owners pour their hearts and souls into their enterprises. It becomes their way of life. Their business is probably the primary revenue and income producing asset for their families. But, and this is key, their families have so much more at stake than the actual take home salary of the owner. For instance, a business owner may be paying him- or herself a $50,000 or $75,000 salary, but the business may be worth hundreds of thousands, or even millions, of dollars. In fact, the tax incentives are for the business owner to pay him- or herself as little as is allowable by IRS guidelines, and keep as much in the business as possible.
So the small business owner must take the topic life insurance very seriously. Not only is the family's income in jeopardy if the business owner suffers a premature death, but the family fortune, as represented by the business' value, may be vulnerable too. The business may close its doors with out the owner. Or, it may have to be sold, and in such desperate times the family may not get the full value for the business. At the very least, if the family keeps the enterprise running, the volume of business would be expected to drop as a result of the change in leadership.
It's a shame when the surviving family doesn't get the full value of such an asset. It's also regrettable that the family doesn't get the full benefit of what the business owner spent his life building.
The proper life insurance can prevent this tragedy in two ways.
The surviving family could take the death benefit from the policy and hire the right kind of executive to run the business. This way, they are keeping the producing asset in the family. And, with the right person hired to man the helm, the business can be expected to continue to produce. In effect, this is key person insurance. The policy can't replace the lost mom, dad, sister, or brother, but it can replace the functionality of the owner in the business. To keep it producing income. To keep it's value up. To help it survive and be a legacy of the owner and the founder.
The second way is for the policy to pay the value of the business to surviving family. That way, they don't have to worry about continuing the business if they can't, don't want to, or don't have the ability to. For instance, we recently wrote a policy on a sculptor. He has a business that makes marble and granite architectural replacement pieces for historic and municipal, mainly state and federal, buildings. He and his talents are the business. Perhaps his spouse could find another sculptor to take his place. But people with this ability are apparently few and far between. So the plan is for the face value of the policy to compensate the survivors of the business owner if her were to die prematurely, as there would be little opportunity in selling the business.
Are you a small business owner? When did you last plan for the succession of your business? It may be your family's most important revenue producing asset.
Monday, March 16, 2009
First, I am not a politician. So this is not a politically partisan piece: I am not writing a commentary on the relative merits of the President's economic stimulus package.
Second, I'm not an economist. I just write from what to me is a common sense perspective.
Third, I'm writing for individuals, not the society at large. Which is to say that if everyone did what I am writing about, we'd probably be in a world of hurt, due to unintended consequences. But I am confident most people won't. Most people are more interested in consuming than saving. Most people operate for the short term, not the long term. Most people are only interested in what is right in front of them, not what is right down the block.
OK... enough. Now my premise: If you spend more money than you have, eventually you have to pay it back, and with interest. And there are only two ways to pay back extra spending (and interest): cut your spending somewhere else, or earn more money to make up the difference.
So it is with our federal government. The economic stimulus is calling for massive amounts of federal spending, most of it being borrowed. More is being spent than is being levied in taxes. Either the federal government will have to drastically cut spending in areas such as health care, social security, defense, and salaries, or taxes have to go up to pay for this mountain of debt we are accumulating.
Recently, Newsweek ran an article (http://www.newsweek.com/id/188154?from=rss) which stated that government spending is 47% of GDP with the current stimulus package. In other words, the federal government is spending 47% of everything that is being produced in the country right now.
To my layman's view, I would expect that eventually federal taxes will have to be raised to tax at least, on average, to 47% of your income. What would it be like to give half your income to the federal government? Is that economically responsibile Not if it's coming out of your own family's coffers.
Now, we don't know yet what kind of tax increases the federal government will impose. I expect higher income taxes, perhaps with lower bands. I expect higher unemployment taxes on businesses. In fact, some state governors want to refuse some stimulus money because their unemployment taxes will go up. We may see a rise in our social security taxes, maybe coupled with a reduction in benefits, or an extension of the age at which people become eligible for benefits. There some talk of re-instituting the "death tax." This means lowering the threshold of the value a person's estate so more estates can be taxed, perhaps coupled with higher estate tax rates. I've also heard that the capital gains tax might be increased.
Just be sure that the federal government will impose higher taxes. There is no free lunch. There is no free stimulus. The bottom line is that we know that money being spent today has to be paid back. And if the Federal government is spending 47% of GDP, then that would be a good approximation of how much of our own gross domestic production will be tapped for federal taxes. The economically responsible thing to do in my opinion is to anticipate the increase in taxes, and plan accordingly.
What are our options?
First, make sure you are enrolled in your employer's 401K if there is one. This is funded with pre-tax dollars, so it reduces your taxes today. Many employers also match part of your contributions. Your money grows tax deferred until you withdraw it at retirement.
Second, make sure you maximize your IRA contributions. Again, this reduces your taxes today, and grow tax deferred.
A Roth IRA is a good choice to grow investments tax free, although contributions are made on an after-tax basis.
If you are worried about the volitility in the stock market, an annuity may be a good choice for these investments. Ours guarantees a 3% rate, but currently pays a higher return.
Speaking annuities, non-qualified (meaning the contributions are not tax deductible) annuities still grow tax deferred. They're kind of like a Roth on steriods, in that you don't have a limit on what you can put into an annuity. So, if you are worried about how high taxes might go, you may want to look at an annuity, especially if you have more to invest than is allowed in a Roth. Look at it this way: if the income tax burden averages 47% of your GDP, a 4.6% yeilding annuity (our current rate) is like getting a taxable yeild of 6.72%.
Finally, people who want to avoid crippling taxes may want to consider a cash-value life policy. There are some very good--and legal--strategies so that life policy holders can accumulate and use their cash values in their life policies outside of the tax structure. And that is a good thing, especially if the tax structure gets more burdensome like we expect it will have to to pay off the massive federal deficit.
The economy rewarded ever increasing home prices. You and millions of others were lured into the belief that if you continued to buy ever bigger or ever expensive homes, you would be rewarded with more and more net worth. There would always be a buyer willing to cash you out so you could walk away with thousands or hundreds of thousands in your pocket. Maybe you were one of those who bought two or more homes--one at the beach and another in the mountains--with the "knowledge" that you were moving faster down the road to higher networth because you had more than one property appreciating in value.
But now you've been caught with an illiquid asset that is worth less than what you owe on it. It might only be $10,000 or $20,000. But here in Northern Virginia, I personally know of many people who owe $150,000, $300,000 or even more than $500,000 on their homes than they are currently worth.
We know home prices will rebound. Eventually. We just don't know when or how long we will owe more than we can sell them for. But let me ask you a question: "What would happen if you or another income producing member of your household were to die before your home price rebounds? What would you do then?" Right now, the answer is that the surviving spouse will be left with a home they can't afford to pay for, and can't afford to sell because they owe more than it's worth.
What is a responsible solution? Not bankruptcy. That will ruin your credit for a long time. Plus, it's expensive in other ways. I've heard of quite a few stories bankruptcies that have hindered people from getting a promoion or a better job.
A ten year term policy to cover the difference in the value of the home vs. the mortgage is an good and inexpensive way to protect your family while you wait for home prices to rebound. Term policies are very affordable, and ten year policies are especially so. And, the younger and healthier you are, the less expensive they are.
It's worth looking into.
But the rules have changed. Anyone who has bought a home in the last couple years probably owes more than the home is currently worth. In fact, in many of the previously "hot markets", like the one I live in, prices have fallen so much that many people who have bought in the last 5 years may owe more than their homes are worth.
Real estate values will come back. We don't know how long it will take: it's an illiquid asset. Historically it's been artificial to use personal real estate as a bank or savings mechanism to replace investments. But, the unprecedented rise in real estate prices has been very seductive: just buy a bigger, more expensive, more prestigious home and you will have more money. What seemed like a perpetual rise in real estate prices rewarded consumption, sometimes conspicuous consumption. Everyone could look at what we're worth just by driving by. The seemingly ceaseless rise in real estate prices promoted the idea we were being economically responsible by consuming. Some people even extended this idea to second homes and vacation homes.
Well, the last couple years have been painful. The rules have changed. We see real estate in more realistic terms: a long term, and illiquid, asset. Personal real estate--our homes for instance--have taken on more of their original meaning--a place to live, to build a family, to feel secure in. The rules have changed, in that we see that to be secure, we have to pay attention to earning "new" money. The rules have changed, in that our economic future is tied to the ability to earn and save, not consume.
Insuring our family's income stream is more important than ever. Many families may not have sufficient equity in their homes to replace one of the wage earner's income. So life insurance carries with it fresh importance.
And, we've been reintroduced to the idea that to grow assets, we need to take money "off the top"--meaning before we spend it on other things-- for savings and investment. Many people have been soured by the huge declines in their mutual funds in the past couple years. So for these people, annuities--which shelter growth from taxes, plus carry a guaranteed return--are looking not only like very responsible investments, but also very attractive ones as well.
Tuesday, March 10, 2009
"Wow," I thought. "This guy just suffered about a 40% drop in his total family income," I guessed, "and he wants to add to his monthly outlay?"
"You know, most people want to cut out expenses when a spouse looses a job. But you're wanting to increase you monthly expenses?"
"No, not at all. We're going to reduce our monthly budget. We have to. That BMW I'm leasing is going back. That's $395 a month, plus tags, taxes, gas, and insurance. So I figure there's an easy $500 a month in savings. We've cancelled our vacation plans for this year. That'll save $4500. We're stopping eating out. That's worth at least a couple hundred a month. And my Harley's for sale. That should bring in 15 Grand. But you know how tough the job market is right now. And I'm the only provider for the family. It's hard now-- can you imagine what it'll be like for my wife and kids if I were to die? They'd be destitute."
I thought this was incredible. The man was looking at "the worst that can happen." It was bad for his wife to loose her job. It would be the worst if she had to head up the family in this economic climate and jobless.
Reality was the policy wasn't expensive for the man. Under $50 a month. But the face amount would replace his income. And, it bought better sleep every night for him and his wife...knowing that if the worst did happen, the family would be taken care of.
Saturday, March 7, 2009
A Foundation for Economic Responsibility: "What's the Worst That Can Happen?" --A Tale of Two Families
So, what is the worst that can happen economically? Well, if we are part of a family, the worst is that our family is deprived of our income either because we died prematurely or became disabled. Not only will our family grieve our absence in their lives, but the lack of income will make their lives considerably worse.
Actually this happened last year to two acquaintances of mine. One was 42, the other 49. They died in unrelated accidents about 30 days apart. The first one left a spouse and three children: 20, 18, and 9. The other left a spouse and two daughters, 21 and 17.
The first one had a small group life policy--her annual salary--with her employer. It was enough to bury her and pay her final medical bills. Her spouse is trying to support his kids on 62% of their total family income. One is in college, the other wants to go. The tough thing is he can't stop working for any length of time. If he does, the family will financially fall apart. He can't take time off to be with his kids, especially the youngest who is having the worst time.
The second one had enough insurance to replace his entire income indefinitely. His wife invested the entire amount in a secure investment and is living off of the proceeds. The oldest has stayed in the private college she is attending. The younger one can keep her plans for college too. His wife doesn't have to work outside the home unless she wants to. So while his wife misses her husband, and his daughters miss their father, their lives are not financially devastated like the first family. There is an emotional hole because of the unexpected death, but not financial ruin.
The reality is most people do not have this economic foundation to the degree they need it. And while their economic houses look good on the outside, a lack of a firm foundation against "what's the worst that can happen" will lead to a collapse if in fact the worst occurs.
Finally, it's easy to deny the need for a firm foundation such as this. After all, like the foundation of a home, the relative strength or weakness of a foundation is not readily apparent, expect in times of stress. But,like a home's foundation, if you wait until you need this foundation for economic responsibility, then it's too late. The damage is already done.
Friday, March 6, 2009
I've named this blog 'The New Era of Economic Responsibility." To some this may seem faddish, given our current economic climate. However, the topic has been of great interest to me my entire adult life. See, I've been blessed by two generations of fore-bearers who have lived responsibly, working and saving, so that they and their future generations would have something significant.
My paternal grandfather was an immigrant. He left school at age 8 to help support his family. Times were very tough. At age 21, his boss took him out for a steak dinner. My grandad said he was terribly embarrassed because he had never had steak before and didn't know how to eat it! I can't imagine. Yet, he always worked more than one job. He went to night school, got his high school equivalent, and eventually his bachelors and masters. He saved all his extra and invested wisely. He was a model of economic responsibility.
My dad was thrifty as well. I'm one of seven kids. There was money for all of us to go to college or other post secondary school if we wanted to. That gave not only me, but my brothers and sisters, a huge advantage in adult life. He lived the model of economic responsibility. Even today, having been deceased for 14 years, he is still taking care of my mom. She is in an excellent nursing facility, not having to worry about her monthly bills, because his investments--his life of economic responsibility--is taking care of all her needs.
Likewise, I have attempted to live according to these principles. In fact, I am in a profession that supports them--investments and insurance. I work for a company that has modeled these principles for over 105 years--it hasn't gotten involved in the sub-prime mess and the "mortgage backed" securities house of cards.
The goal of this blog is to share thoughts and case examples with you about what it means to live in an economically responsible way. Hope you enjoy it. Hope it helps you make better decisions. And, your comments are appreciated.
~Richard B. Osmann, Ed.D.