Financial Blind Spots

Have you ever switched lanes while driving and only at the last second did you notice a car that had been in your blind spot? Or worse yet, nearly been in an accident because a car next to you started to turn into your lane without seeing you…and then didn’t even pay attention when you honked? Well, that can happen when it comes to your personal finances and protecting yourself and your family. Just like driving, there are some things we can control ourselves and others we need to pay attention to in order to see how they will affect us even though the rules and laws might not allow us to make changes to what is currently in place. In addition to watching out for taxes, protecting against income loss and unforeseen health and life changes, our own self sabotage can contribute to creating, and living within blind spots.

When it comes to taxes we are inundated with information. The U.S. House of Representatives lists the Internal Revenue Code (Title 26 of the United States Code) as having 6,499 pages in .pdf format. Reading this is like reading all seven Harry Potter books and then rereading The Philosopher’s Stone, The Chamber of Secrets, the Prisoner of Azkaban, The Goblet of Fire and The Order of the Phoenix. While it is hard to remember everything in the code, utilizing accountants and financial advisors who can make suggestions based on your specific situations may help reduce taxable income or reposition assets that offer more favorable tax treatment for your goals.

Similar to taxes, there are many different ways we can provide protection for ourselves, our families and the physical structures and material possessions we utilize. Sometimes it is best to take on the risk ourselves by self-insuring and other times it makes sense to shift the risk to someone else so that we don’t have to come out of pocket more than just a monthly premium payment. What to protect, and at what level depends on many factors including replacement cost and the length of time the protection is needed. Not making the adequate protection decision has the ability to affect you and your loved ones in major ways.

Inadequate protection is also an example of self-sabotage. When we put ourselves in situations that limit our ability to make important decisions or don’t prepare for future changes appropriately, we are effectively tying one hand behind our backs while we try to hit a baseball at 95mph. How we rebuild or get ahead of these self-sabotaging situations can create a compounding effect to lift our personal financial situation to where we get to make decisions instead of decisions being made for us.

The information regarding taxes is to be used as a guide. This is not tax advice. Please consult with your accountant and financial advisor to see how your specific situation is affected by the federal and state tax laws. Unlike where a gym trainer may want you to raise the bar with maximum effort, you may want to lower the tax bar with maximum effort. Credits reduce the amount of taxes you owe, and deductions reduce the amount of income subject to taxes. The tax laws have changed due to new regulations put in place that can affect your tax situation now and in the future. Taking advantage of legally available strategies, whether it be through saving money or claiming certain deductions, should be discussed throughout the year and when there are changes to your household size, income or other financial situations that change.

So, what can you do? The government allows you to set aside money in accounts earmarked for later in life (i.e. after 59 ½ when some of the penalties and restrictions are gone). Some, but not all, include 401(k) plans, 403(b) plans, Roth IRA, SIMPLE IRA and SEP IRA plans. These accounts allow you, if you meet the qualifications, to set aside money either before-tax or after-tax; meaning you can receive the tax deduction today or you can pay taxes today and have the ability for your money to potentially be taken out tax-free at a later point. A financial advisor and a tax advisor can aid you in determining the best strategy for your specific situation.

The cost of education has been increasing over the years and more and more dollars are needed to pay for both public and private higher education institutions. There are different strategies to set aside money with some allowing you to take a tax deduction today and others using after-tax dollars that can potentially be withdrawn without being taxed. These strategies, similar to retirement focused accounts, have contribution limits, income limitations, potential penalties and risks associated with the underlying investment(s). Some examples include 529 Plans (college savings and pre-paid), Coverdell Education Savings Account, UTMA/UGMA accounts and Roth IRA accounts. In some cases, more than one strategy can be used based on when the money is needed, how much is needed and what the ultimate purpose of the savings is for.

Whether for retirement, education or another savings strategy, there are constraints as to when money needs to be set aside in order to qualify appropriately. Some contributions, such as 401(k) plans or 529 plan contributions need to be made prior to the end of the calendar year whereas you are allowed until April 15th (or the next business day the government declares taxes are due) for Traditional IRA and Roth IRA contributions. In some instances, prior year SEP IRA contributions may be made through the extension filing deadline which is usually around October 15th of the current year. Deadlines are important and working with specialists can help you stay on track and avoid these tax blind spots that may end up saving you money, not just this year, but for many years to come.

Finding opportunities within the tax code to reduce tax liabilities can be quantified nearly instantaneously. But what happens in situations when we can’t foresee what the outcome will be? How can we prepare for that? The answer is protection. Protection can come in the form of insurance - whether that be self-insuring or transferring the risk to someone else (usually a company). In today’s world you can insure just about anything from your house to a boat to your mustache and teeth. Knowing what to insure and for how much are important factors to make sure you are covered adequately and are not overpaying for the protection. Many of us know that if we own a car we at minimum need to maintain liability insurance, but can also get collision coverage (some states require this). This can protect us in case we get into an accident and the potential high cost of vehicle repair or replacement. Protecting earning potential through disability insurance, extending liability and damage coverage to a home or auto in the form of an umbrella insurance policy and various forms of life insurance are just a few types of protection that are not required but can provide additional benefits that aren’t as transparent as a check or bank transfer.

Say you were to bump up against something sharp and cut your leg, the wound may be small and may heal on its own or with minimal effort and medication. Sometimes, however, the cut is large enough to create significant damage or infection. There usually isn’t a good way to tell which one it will be before it happens so having health insurance that allows us to go to the doctor and pay a co-pay or office visit may be cheaper (factoring in the premiums) than having to pay the full hospital bill without using insurance. Every time we consider whether or not to protect something or someone we have trade-offs to make. If there wasn’t a cost, we would insure everything! Some things we can self-insure, but others are generally too large or would take up too much of our existing assets and we need to push the risk to someone else. If you have an old car that is considered a “beater” worth $500, it may not be worth the cost of including collision insurance in your policy because you could pay more in premiums than what you would receive in an insurance payout. In this case, you could self-insure by saving money on your own and using that to pay for a different car when the time is right instead of paying additional premiums.

But, what about your lifetime earnings? Assuming no inflation or change in salary, if you work for 40 years and earn $75,000/year, you will earn a total of $3,000,000 over that time period. What happens if you get injured and can’t work after year 5. What happens then? There’s a chance you can qualify for social security disability benefits, but will that be enough to live a desired lifestyle? Disability insurance can provide protections if you weren’t able to work due to a qualifying disability. The insurance may not get you the full $3,000,000 but it would provide you with more than $0. This is where an unforeseen event can end up costing millions of dollars over a long period of time without an adequate protection protection plan.

There are numerous assets and situations that can be protected, whether through additional savings on your own, or through various types of insurance products. When deciding what to insure and for how much, working with your financial advisor is an important part of the process by reviewing your overall situation to help you determine how best to distribute your income and expenses so that they align with both your short and long-term goals.

In addition to taxes and various forms of protection, blind spots can be lurking in areas we didn’t know existed. These types of blind spots are not created because of a car we purchased or because we wanted to protect our earnings potential; they are created through self-sabotage. If you’ve ever had to cram for a test, you have created self-sabotage. If you’ve waited too long to go to the airport and the TSA lines were so long that you were nervous you would miss your flight, you’ve created self-sabotage. Sometimes we say “phew!” and we make our flight on time. Other times we have to pay upwards of $200 to change our plane ticket because we missed our flight. Self-sabotaging your personal finances can add stresses and financial costs. These incidences can potentially be avoided with a little bit of foresight, a strategy and a helping hand.

Carrying too much debt can be a burden that weighs heavily on just about all aspects of a person. Debt can come in the form of a mortgage (or even rent payment), auto loans, student loans, credit card debt, 401(k) loans, home equity loans or even personal loans. Some of this debt can feel like a 2,000 pound anchor that you’re carrying with you everywhere you go. It can prevent you from participating in activities that give you enjoyment and put smiles on the faces of loved ones. Creating strategies to reduce the amount of debt and allocating income appropriately through budgeting can help reduce stress by being able to create a finite end.

Certain types of debt are sometimes created from a lack of an “emergency” or “opportunity” fund/account. These types of accounts can be simply defined as “dollars when you need them”. There are a lot of theories about how much is needed in this type of account; but due to each person’s specific circumstances, overall assets (including how the assets are held), and their ability to tolerate risk you wouldn’t be surprised to hear 10 different answers if you asked 10 different people. The key is to understand what the money’s for. You may want to have money you can access if you change jobs and there’s a lag time when the next paycheck is going to come. You may want to have access to money in case you experience a larger than normal hospital bill that isn’t fully covered by insurance. Or, you may want to take your family on a surprise trip to Disney World because you found an unbeatable airfare deal. By utilizing these dollars, you can avoid using debt instruments that charge interest, can hurt your credit score and limit your ability to meet future expense obligations. What if you don’t have enough saved? How can you build it up? Working with your financial advisor to develop a strategy and help set up systems that work best for you and your savings goals are a few ways to give you peace of mind that what you’re working towards can be accomplished.

Sometimes life throws us curve balls that we see coming but just can’t hit; and sometimes we’re fooled by the pitch completely. Planning ahead for specific pitfalls such as protecting against a loss of income or contributing to a retirement plan to reduce taxes are quantifiable and can more easily be measured. Some of these blind spots we can’t see coming but knowing that we’ve been setting aside money or repositioning accounts to be ready for the unknown can keep us one step ahead15