Paul Ferraresi

The potential earning power of a wage earner is one of the greatest assets of a family. The main objective of life insurance is to protect the insured’s family and creditors against financial loss due to the death of the insured.

With two income families, the analysis is just as significant for each spouse, even though one may have higher current earnings.

Determining the best policy starts with an analysis of specific needs. Such needs vary, of course, from family to family, but the following categories normally apply:

• Final lump sum expenses, funeral and debt repayment
• Income for the family until children are self-supporting
• Life income for the surviving spouse
• Special needs, such as education and business situations
• Retirement income needs

Once the needs are identified and measured, the next step is to determine other sources of capital, income or benefits available. The difference between the family’s needs and the money available from other sources represent the amount of life insurance which is needed.

After the amount of the life insurance need has been determined, we can evaluate what type of policy best suits your current financial situation. Your cash flow, other investments and savings patterns will be factors in making this decision.

Permanent life insurance builds cash values that will grow even if the insured is disabled. Term life insurance offers the maximum amount of protection for the lowest initial outlay.

If term insurance is indicated for all or part of the protection, it is very important to consider the conversion options should you wish to change the policy at a later date. Closely examine the scheduled premium increases or benefit reductions as they vary considerably between life insurance companies.

A family’s current and future tax structure should also be considered when evaluating different forms of life insurance. For example, variable universal life has some very attractive tax benefits, but they would be unusable to a retiree who had not been able to substantially fund the policy or who was in a very low income tax bracket.

The only money you will ever have to spend, lose or invest is what the government allows you to keep. Many taxpayers do not understand that they do have a choice as to whether they will pay a small or large amount of income tax. Why pay the IRS investable funds you are allowed to keep?

Tax-advantaged investments are not “loopholes” in the Tax Law that the IRS is out to plug up. They are not immoral, as some would have you believe. A common fallacy is to confuse tax evasion with tax avoidance. Tax evasion is illegal and punishable. Tax avoidance, on the other hand, is legal and is encouraged by the lawmakers. The United States Congress promotes the shifting of funds from the taxable sectors of the economy to areas of public need or good by passing laws which create tax-deferred, tax-sheltered and even tax-free investments.

Many, ignorant of the nature of the tax-advantaged investments, would have you believe that you are “robbing” the economy of tax dollars by not giving your taxes to the government to spend in their great wisdom. Such advocates are ignorant of the fact that tax-advantaged investments are put into housing, energy, food, strategic metals, research and development, medical needs and transportation.

Rather than being filtered through bureaucratic mazes to the economy, these otherwise diverted tax dollars are being applied directly to where the need lies – creating new jobs, expanding industry and adding to the growth of the country.

Understanding that tax-advantaged investments can be risky should be a prerequisite to becoming involved in them. Although there is the possibility of “hitting it rich” with such endeavors, many have and many will continue to chance the loss of their investment. Yet when compared with the alternative, a 100% chance of loss when paying taxes, such investments can look quite attractive. After all, which investment will offer the greater possibility of providing you income in your golden years or at any other time?

The taxpayer also needs to remember that Congress has passed tax incentives because such investments are risky. Tax advantages are provided to encourage investing in high-risk areas that provide for the social good of the country.

Being involved with a taxadvantaged investment requires a proper frame of mind. It is your sleep that will be lost if you are uncomfortable with such an investment. Such investments are complex – particularly with the ever-changing tax laws. Working with a knowledgeable financial planner will help you avoid many of the pitfalls and help you keep more of your hard-earned dollars from taking a one-way trip to the IRS.

When the Alternative Minimum Tax (AMT) was instituted, it was designed to make sure the top American income earners paid their “fair share” of taxes. The tax rate was a flat 28% with very few deductions allowed. Over the years, Congress has made very few attempts to adjust the level at which Americans will be taxed at the AMT level. Consequently, as inflation has raised individual incomes over the years, many now cross the threshold level to pay AMT. Well, over one-third (33%) of Americans now pay the AMT due to increases in their pay. You see…you calculate the regular tax and the AMT – whichever is greater, you pay.

In trying to fund the new healthcare plan (that only 30% of Americans wanted), Congress set up another trap for everyone…not just the “rich.” Better plan now for future tax increases coming your way as your income rises in the future. The new program is a Medicare surtax.

Strategies for the tax involve creating effective tax deductions under new investment income rules, choosing the right investments, insurance products and business structures, and picking the right time to set up trusts. The idea is two-pronged but basic: Reduce overall taxable income, and reduce investment income.

The surtax adds a 0.9% Medicare Hospital Insurance Tax on earned income over $200,000 for single taxpayers and $250,000 for married couples, and an Unearned Income Medicare Contribution of 3.8% on investment income for taxpayers with adjusted gross incomes over $200,000 for single filers and $250,000 for married filers.

The 3.8% is assessed on the lesser of net investment income or the amount of modified adjusted gross income over the threshold. Net investment income is investment income minus certain expenses and includes interest, dividends, capital gains, annuities, rents, royalties and passive activity income. It does not include active trade or business income, distributions from IRAs or other qualified retirement plans, or income considered for self-employment taxes.

Keeping income below the threshold will be a key line of attack. Ways to do that include stashing money in tax-exempt investments, including municipal bonds. Non-qualified deferred compensation, life insurance policies, and oil and gas investments are other ideas.
Begin now, today, to take an aggressive move in shifting your investments to avoid these future taxes. Do not wait until the “crowd” starts to move their monies. Talk with your advisor now and systematically move your monies. The “crowd” will wait until after they pay the tax to think about making changes.

Ah, discipline or regret…

THE IMPORTANCE OF GOALS

A cash flow plan will function best if it reflects your goals, whether long-term or short-term. The purchase of a pleasure boat in three years or the decision to remodel your basement next winter should influence your cash flow plans.

The goals that you have already set will help you shape your personal version of this system. Refer to them often.

As you achieve some short-term goals, or begin to see significant progress towards long term-goals, your enthusiasm for this process will increase – and that will make the system even more effective for you.

ESTABLISHING YOUR SYSTEM

What should your system contain? There are four factors that will help you establish control over money:

• INCOME/EXPENSE
Identify and isolate income and disbursements (referred to as expense). You will consider whether income is gross, or net (the amount you actually have available).

• CATEGORY
Define the kinds of income you receive and the kinds of expenses you incur. Categorize them according to the fixed or flexible nature of the item.

• TIME
Your system should be based on a monthly structure. You should quantify your income and expense within a 12-month format.

• AMOUNT
Income and expenses are expressed in dollars.

Once you have qualified all financial transactions, you will be well on the way to controlling your cash flow, rather than letting it control you.
 
PERIODIC FIXED EXPENSES

Many people have lost control over cash flow because they have no system to handle periodic known expenses of a substantial nature. Good examples of this type of expense might be a large real estate tax bill of $1,500 due every March, a life insurance premium of $840 due in November, or an IRA deposit of $2,000 which must be made by April 15th.

What people frequently do is remember the bill a month before it is due and start scrimping, but it is too late! So, what happens then? In the ensuing months, they start running behind on bills or they simply do not make the planned payment at all. Interest charges are then added, and their attitude starts to decline.

The solution is to schedule these larger payments and start saving for them on a monthly basis. For example, for a small additional amount, an automatic bank deduction can be made regularly to cover the $840 life insurance premium.

The $1,500 tax bill is due again in 10 months. Why not set $150 aside into a special savings or credit union account? Then when it comes due, you will have the money. Afterwards, you can reduce the monthly savings amount to $125 since you will have 12 months to accumulate the next payment.

If the IRA $2,000 deposit is due again in eight months, put aside $250 each month until then. After it has been paid, the amount to set aside is only $166. Furthermore, you will be earning interest on these escrow funds, rather than paying interest as a result of poor money management.

Initial savings ($150 + $250) $400 monthly; thereafter only ($125 + $166) $291.

SAVE REGULARLY AND SYSTEMATICALLY

It is important to assign a portion of each paycheck for your savings and investment program. Consider it an obligation just as important as any other monthly obligation.

In addition to saving a portion of monthly income, we strongly urge that any money saved by tax planning each year be invested the following year. This will give you an additional source of investment funds as well as a means of reducing income tax liability on a regular basis.

What is Cash Flow Management? Every successful business relies on a financial system to carefully control income and expenses. A business must have a system to know its present financial status, and more important, to plan for its future financial moves. A corporation cannot place a $40,000 inventory order unless its controller knows next month’s receipts will cover the order.

Your personal financial situation is comparable to that of a business. Both have concerns for profit, income and expenses, and spending decisions affected by anticipated circumstances. Consequently, personal cash flow management is designed to handle your financial situation like a business, and you will function as the controller.

A SYSTEM, NOT A BUDGET

Cash Flow Management is a system, not a budget. It will allow you to see your financial situation from a long-term, systematic viewpoint. You will see how one move, such as a periodic tax payment, can affect your disbursements for several months prior to, and following, the actual payment. Budgets are too immediate in scope to allow you to relate a March income to a July expense.

It is essential for you to begin a systematic savings and investment program to accomplish financial and retirement goals. Every successful business relies upon a system to control income and disbursements. Your personal financial situation is comparable to that of a business, and is no less important!

Most people have not saved as much as they would have wished. The reason is not that they did not intend to save, but they did not have a system. Lacking a system makes it very easy to be distracted by the many opportunities to spend earnings.

Your financial needs and desires present unique situations, and your system must be flexible enough to accommodate whatever you require. Tailor it to fit yourself and your family; do not rely on what your neighbor does.

While your friends or neighbors might be managing cash flow to save for a European vacation, you may need to direct cash flow towards current tuition for a degree. Your system should be flexible, but also rigid enough to be a guide and point you in the right direction.

If your cash flow system becomes a hindrance, do not abandon it; redesign it. With sensitive shaping to your needs, it will allow financial freedom rather than acting as a financial barrier.

A Personal Cash Flow Management System, if used consistently, can be of great value in helping to gain control of your personal financial situation. It will ensure that there is always cash available to pay bills as they come due. It will also help you save more money in a systematic way.

Time is your greatest ally. The more time you have, the less money you will need to save and invest. The less time you have, the more money it will take. Procrastination is a deadly enemy of your goal to retire with financial dignity.

Part Two Next Week