Episode 6 – Savings: Short, Mid & Long Term Saving

Episode 7 – Lenora Edwards
July 12, 2019
Episode 5: Savings – Common Mistakes
June 3, 2019

Short, Mid & Long Term Saving

Three Outlooks on Saving

Thom Allison and Jessica Kirwin of Allison Spielman Advisors discuss some strategies for saving money in the short, mid and long term time frames.


Thom: Welcome to the Financial Wheel Podcast.. I'm Thom Allison your host. The purpose of this podcast is to equip you to have the right conversations about your money. In the last podcast we talked about some of the common mistakes that we see people make with their savings plans and with their savings strategies and what we want to do in this podcast is to talk about strategies that you can use to help you avoid those common mistakes. Just as a starter here I realize you're probably right in your car maybe you're working out or something so you're not gonna be able to take notes. Don't worry about that. We're going to have all of this information on our web site FinancialWheel.net where you can review this if there's something there that really hooks your your attention. It's also a place where you can go in and put your questions and we'd love to have your questions there so that we can address those in future podcasts. So today we're going to focus on short term savings goals midterm strategies and long term savings. Our guest in the last podcast was Jessica Kerwin. She's a certified financial planner and a colleague of mine at Allison Spielman Advisors and she's with us here again today. If you didn't hear that introduction that she gave last time you probably should listen to it because she's a really great example of someone who has realized that the purpose of money is to help you live out the life that you want to live. And she's made some great life choices and is using the money that she's able to earn to support those life choices. So she's just doing a fantastic job with that. She's with me here right now. Welcome Jessica. We're really happy to have you with us again.

Jessica: Thanks Thom. I'm really excited to be here.

Thom: So we're going to want I talk about short term savings goals so why don't you maybe start off with just giving us a few examples of some of the short term savings goals that some of our clients have shared with us.

Jessica: Sure. Yeah. As Thom mentioned these would be goals that you hope to accomplish in the next two years or so. So the three tools we want to talk about today are CDs, high yield savings accounts and short term U.S. government bonds. So a lot of our clients they're saving for trips either international trips going to Europe or.

Thom: Yeah. You know types of trips that are designed to create memories for them for themselves and for their families.

Jessica: Yes. So ones that are very intentional. Also maybe saving for sporting activities for your kids. So one personal example that I have is saving for skiing next year. We have a three year old. My husband I have a three year old and and we want to teach him how to ski next year. So we're saving up for the ski passes and the lessons and the equipment so that next year we can teach him how to ski.

Thom: That'll be great. And then I'm sure that's gonna be followed by a special coaching and all that as he works his way into the Olympics and we're looking forward to that.

Jessica: No pressure. Scholarships.

Thom: Yeah there we go. There we go. That's probably one of the tools. But that's not the one that we want to talk about right now. I think the tools that we really should talk about are the tools that are really good for. For short term savings.

Jessica: Ok we'll talk about the tools so CDs, they're certificates of deposit and generally you specify a period that you would invest in. So a timeframe. So a year there are 12 months. These are 24 month CDs those are generally guaranteed investments. So as long as you leave your money in them you'll get the return that that they state. Then there's online high yield savings accounts and that's similar to you know a savings account at your bank. But generally because these are online banks they're able to reduce their costs and give a higher higher return.

Thom: Yeah those are good. Another one is short term government bonds. So you know Treasury bonds are generally ones that mature within two years sometimes a little bit less and they're issued by the U.S. government and so they are guaranteed or they're least backed by the credit worthiness of the U.S. government which essentially means they're guaranteed. So that's another good vehicle too. Yeah. So there's three that we can talk about. So you know certificates of deposits high yield savings government bonds. They all seem to have common characteristics.

Jessica: So one common characteristic is the fact that all three of them are safe investments. And what do we mean by that. We mean that we want your money to be available and there when you need it. So in the short term we don't want to exposure your money to risk. And that means that these investments are volatile.

Thom: Yeah they're not volatile and you know when we talk about risk we want to make sure that you know if you've saved eight thousand dollars to take a trip that when you're ready to spend that eight thousand it's there. You know the problem is if you invest that in the stock market for example it's entirely possible that you're a thousand dollars will suddenly be worth sixty five hundred dollars on the day that you need it. You don't want to have that happen. That's not a pretty picture at all. So that's so that safety is something that's really key.

Jessica: Right. And then another key point is that the investment is liquid. And so what does liquidity mean? And that means it's the how fast you can turn that into cash. So as we mentioned with the online high yield savings that is in cash as far as liquidity for CDs they typically have a time frame that you're investing in and and so depending on when that timing is up that's when the money will be available.

Thom: Yeah and I think it's worth pointing out too that there's because I think it's a bit of a misconception about CDs as I always say that there's a penalty for early withdrawal and so people think well okay if I put five thousand dollars into a C D and it's a one year maturity and I take it out in less than one year then I'm gonna get less than 5000 dollars back and that's not really what the penalty is what the penalty says is you don't earn all the interest that was paid there so you'll still get your 5000 thousand dollars back and you'll get a little bit of interest but you won't get as much interest as you would if you held it until it actually matured in that 12 year time period. So it's probably a good idea to keep that in mind as well.

Jessica: And then the third principle is yield. So what do we mean by yield? And that's the rate of return on these investments.

Thom: Which is pretty lousy. I mean it's pretty lousy if you're going to compared to what you can do in the stock market you know or you know maybe in real estate or something like that because what type of rates returns are we looking at?

Jessica: Currently in today's market maybe between 2 and 4 percent.

Thom: Yeah actually that's pretty good. I've seen him you know at 1 percent or even lower we've been in a low interest rate environment for quite a while now. So but is that really important to make a lot of money on these short term savings.

Jessica: No I mean for me if I had a goal and I needed to make sure that my money was there that would be important. That my money was available not not seeing how much money I can make on it. I'd rather not gamble.

Thom: Well that makes an awful lot of sense. So all three of these have three common characteristics their safety liquidity and yield. If you take the first three letters of that S L Y you end up being a SLY investor. And that's what you want to be with the short term savings is a SLY investor because you want to have safety first liquidity second in yield third. Okay. Now before we go on let's take a break.

Thom: Welcome back from the break. We're back in the studio right now. And during the break Jessica and I were having a conversation and she gave a really great example of what we're talking about here. You want to share that with us.

Jessica: Sure. So this example combines all three of those characteristics that we were talking about safety liquidity and yield. My husband and I were going into the Peace Corps. I think I mentioned in the last episode and we had some time to save money and we knew we wanted to have that money available when we came back to the United States. And for those of you that don't know the Peace Corps service is two years. So it's a two year stint. So I was researching different options and found that there was a two year CD. And at the time it was making four or five percent. And so I thought this is perfect where you're going to be out of the country for two years we have a lump sum of money and we'll invest that and it will be available for when we come back. And so it meets all those criteria. It was safe liquid when we came back when we needed it. And and it was making. It was making more than sitting just in cash.

Thom: And that's the key right there is that there's a temptation to put this money into your checking account set maybe into a savings account which is still a good option but it doesn't give you the same rate of return. So when you know that you have two years before you're going to need that money that gives you a chance to put it into something that's going to give a little better rate of return than than a checking account or a savings account or that mattress that you're not going to be sleeping in for the next two years.

Jessica: And at the same time we did not want to invest into the stock market because we knew we definitely wanted to make sure that money was going to be available and there in those two years. And generally that's not a long enough time to be investing in the stock market. So we wanted to make sure that that money was available for when we came back. Like you said and one of the other episodes that eight thousand dollars dropped to sixty five hundred and.

Thom: Yeah right when you need it the most. Yeah yeah yeah. You just don't want to be in that position. So.

Jessica: No no no. Yeah we wanted to make every dollar count at that point.

Thom: Now that's it. That's a great example. And we've seen that exact same situation with some of our other clients especially those that are saving for a new house. And you know they're really tempted they get you know you think about it in today's market. You put 20 percent down in a house. You might be having somewhere around 100 hundred fifty thousand dollars and having that sitting there in today's earnings rates making one and a half two percent you're feeling like this isn't very good. I'd better do something with it and you see the stock market's doing better. There's a real temptation to sort of move that money over there and you just have to remember SLY be a SLY investor safety first liquid second yield is third yield as in it's a distant third. It really is. That's not the important thing because when that perfect house comes along you don't want to suddenly realize that you need your money at the end of 2008 when things really tanked on you. So again a common mistake we've seen people make is they get too aggressive with their short term money. Now we're going to be talking about the midterm strategies and again for midterm we're talking about really pretty much in that five to 10 year timeframe. So you want to reach a goal in that five to 10 year timeframe. And when I think about midterm like I said in that you know five to 10 year timeframe and it just reminds me of some clients that I had early on and they had it was actually a five year goal at that point and their five year goal was to take a year off from work and they were actually living on a sailboat and they were going to take that sailboat and they were going to sail around the world. Wow. Yeah I. That's what I said. Can I come along. It sounds like a lot of fun. So. So that was sort of an example of a midterm goal. Do you have an idea of or can you suggest some other midterm savings goals?

Jessica: Sure. I'm thinking of a client right now we're working with. They want to do a landscaping project. They want to build a he and she shed.

Thom: So what exactly goes into a he shed versus as she shed. Great example landscaping projects certainly fall into that category. Some of them aren't necessarily as much fun you have to put a new roof on your house sooner or later if you live in it long enough and so you know there's something that you might have to be saving for too. Yeah I think another common one that we hear a lot about is buying a new car. So you have to replace those cars. Unfortunately wear out. Yeah I know I get my favorite one and you know 10 years later I'm sitting there thinking can I get this to go another 10 years. I really like this car out so they start get expensive when you do that.

Jessica: Yeah. I think another thing to point out is you might not know exactly when you're going to need it. Like you say with a new car. But you know it's gonna be over two years and most likely under 10. So those those are the kind of goals where we're looking at.

Thom: You know when we talked about short term savings we talked about being a SLY investor so safety liquidity and yield were kind of the key thing. But now we've got a little bit more time on our hands and time can certainly be our are our partner in this whole process. So what does that do. How does that kind of change your thinking in your strategies a little bit knowing that you have a little more time.

Jessica: Right. So kind of knowing your timing and when do you need your money to be available. And so some of the guidelines are. Are you going to need your money before your fifty nine and a half? Now. Why is that important?

Thom: Yeah I mean what is magical about fifty nine and a half? You know it, it seems sort of odd. You know I always think about you know you've got a three year old. So for a three year old three and a half is important. You have four and a half gets me more for most people once they get past about five or six at half year. Doesn't make any difference. But here for some reason we got fifty nine and a half. That sounds odd. What's so what's so important about fifty nine and a half.

Jessica: So if your saving let's say in a retirement account such as a 401k if you needed your money before then before age fifty nine and a half you would have a penalty if you took it out earlier than that. So knowing if if you're going to need that money before you're fifty nine and a half is is important because if you want to avoid those penalties.

Thom: Right. Yeah. So I mean that's kind of the magic thing is the government's kind of stamp fifty nine and a half on anything where they give you a tax advantages. We're gonna talk about that a lot more when we get into long term savings. But yeah but. But it's important to realize that you know you could have some penalties involved in getting money out if it saved the wrong place.

Jessica: Exactly. Also knowing your timing is important because depending on when you need it that helps determine how liquid the money needs to be. So if you're not going to need it for eight years you have more investment options.

Thom: Right. Yeah. Yeah. And when we talk about liquidity what we're talking about is how fast can you take an investment and move it into a cash position. Because it's cash that you get to spend. So you know that first guideline is that you're really kind of plan out what you're doing. Know what your timing is. Again it's this whole idea of setting goals. So like with the example of my clients they knew that this was five years from now. Then they kind of set in fact they put a date on that thing an exact date and that's when that's important to have is to know that timing.

Jessica: So did they did they meet their goal?

Thom: They did. They met their goal. They took off. They sailed around the world and just had a great time. Yeah. And you know and back in those days this was prior to the Internet and all of that that this happened so I got postcards. Postcards are cool.

Jessica: Postcards are still fun today.

Thom: Post cards are cool right. What else do you have to be taken into consideration though. Yeah with these midterm goals.

Jessica: Managing your risk especially as you get closer to your goal. So what that means is making sure that your money is there when you need it.

Thom: Yeah. So we're talking about risk we're just talking about making sure that that you don't have a loss of principle. We're not worried about whether you make a lot of money. We're just worried about not losing principle as you start getting closer. Yeah. So. So how do you how do you even manage risk.

Jessica: So one of the ways that we can manage risk is is diversification. So making sure that your money isn't invested in let's say one stock.

Thom: Right. Yeah.

Jessica: Thom you have a famous example.

Thom: The idea I like to tell you about that because what happens if you own one stock you really have two potential outcomes. You could you could buy Microsoft the day that it goes public and you end up making a whole lot of money because you're very very successful with that one. On the other hand you could have bought Bowman calculators. And I think it's probably a fair bet that a lot of you out there haven't heard of Bowman calculators before but they actually were the first commercially successful handheld calculators in the late 60s and early 70s. But then Texas Instruments came along and put one out that was better and as a result of that Bowman went out of business and if you had bought stock and bond and calculators you'd have nothing right now. So those are your two possibilities when you diversify when you buy a number of different stocks what happens is the possibility that your money goes to zero it just disappears. But at the same time the possibility of making huge amounts of money strings also. So you're not going to make as much but you're going to be able to protect it a little bit. So that's what diversification does.

Jessica: And then another way we can diversify is between stocks and bonds.

Thom: You want to have bonds and you want to have stocks and you want to maintain that all the time. And you know what happens is people will say well my stocks are going up and my bonds aren't. Why am I not moving money out of bonds and putting into stocks. And I always think of it as like the kid who wants to make his bicycle go faster. And the way you make a bicycle go faster is you make a lighter. So how do you make it lighter. Well you take off stuff that you don't need on the bike. So the first thing that goes is the kickstand. You don't need a kickstand. If you're going to just lean it up against a tree when you get you know and lock it onto the tree that's fine. Maybe you don't need the headlights on there because you're not going to drive you know ride your bike at night. So that doesn't matter. You don't need a bell you can just yell at people and you're coming up and you're going about to run them over so why bother ringing a bell. Eventually you get to the point where well maybe I don't even need the brakes. I mean I'm just going to ride uphill or I'll ride flat and that'll be fine if I get into a little dip I can put my feet down and slow myself down. And this all works great until all of a sudden you find yourself going over that really steep hill that's long and keeps going down and you keep picking up speed and you lose control and you're in trouble. And that's what happens when you take bonds out of your portfolio. The purpose of bonds is to sit there and brake on when you're going when you when you hit that time in the market when it's going down. So if you get rid of the bonds you get rid of the brakes and then you're in trouble.

Jessica: So you want to be have more and more bonds the closer that you get to the goal.

Thom: Yeah. You want to make sure that you've got stronger and stronger brakes because you don't want to be losing money as you get closer to the goal so and needing it. Yeah. So you kind of shift from having more stocks in your portfolio to having more bonds in the portfolio. So what we've talked about so far is that you need to actually know exactly what your goal is and what the timing of your goal is. That's really pretty important. We saw that we need to adjust the amount of risk as we start getting closer and we do that by adjusting our diversification and by adjusting our our allocation there. So the third guideline is that you want to manage your taxes and I'm going to warn you right up front we don't have Any fun stories about managing taxes it just doesn't happen. There's nothing fun about taxes but they're really important. So we're going to give you some detailed stuff that you need to talk about. Don't worry about if you don't get it all right now because we're going to have a transcript of this podcast on our Web site FinancialWheel.net so you can go there and listen to this. But there is some detail that unfortunately we just have to go through it it's the nature of the business. And but it's very important to know we're going to give you a little bit of information that's going to be really valuable for you as you're carrying on your conversations about managing taxes.

Jessica: Ok so by managing taxes one of the first things you need to pay attention to with your investments are. Is it a long term investment or a short term investment. And what that means is if you hold the investment for over a year it's considered long term and you qualify for long term capital gains tax rates versus short term. That would be a different rate.

Thom: Yeah and those long term rates are definitely more favorable rates. So typically they're like 15 percent versus 27 or 30 percent so you can see the advantage of doing that.

Jessica: Right. And then another consideration is the income that your investment generates versus the capital gains. So what I mean by capital gains is say you buy a stock for 30 dollars and then you turn around and sell it for thirty five dollars. Your cost basis is the 30 and your long term capital gains is the five dollars. Well and then it's taxed at at.

Thom: The more favorable rate.

Jessica: At the more favorable rate and then the third consideration is is matching those gains. The capital gains in your investments with any losses that you might have so that they can offset each other.

Thom: You know so I get a loss in investment and I'm not going to feel good about a loss of an investment. And you know when I'm gonna be inclined to think about is that. Well I don't want to sell this investment at a loss if I hang on to it I can get my money back. Is it really an advantage to selling it at a loss. And if I do sell it at a loss what should I do with that money.

Jessica: Right. So depending on your investment portfolio if say you are selling some stocks that had a gain that those losses can offset the gain. When you're filling out your tax return.

Thom: Ok so if I say if I say sell an investment and I lose a thousand dollars on that investment but then I go and I sell another investment where I've gained a thousand dollars. Those two offset each other. You don't have to pay any tax on that on that gain that. Wow that's cool. That's a. That's a great way to avoid paying taxes. I like this idea. But now you know I really like that investment that had was down. You know what. Can I Can I just buy it back again.

Jessica: No. There are definitely certain rules around that. But you could buy a similar investment.

Thom: So I have a mutual fund that invests in a certain strategy and I like that. And then I find that there is another mutual fund that has almost the exact same strategy. Can I sell the one and buy the other one.

Jessica: Yes you can.

Thom: Ok so I'm still invested with that same strategy but it's with a different fund and therefore I can go ahead and claim that loss.

Jessica: Yes you can claim the loss and you're still invested.

Thom: Cool I like this. Yeah. So that makes sense. So. So in other words I should really you know at least once a year probably spend some time combing through my investment portfolio and saying OK I've got a loss over here but I can find a similar investment so maybe I better harvest that loss. And so that I can use it to offset gains. But what happens if I don't have any gains or I don't realize I don't sell anything so I don't have any gains for that year. Do I, do those losses just disappear.

Jessica: No you can you can claim a loss but you can carry it forward.

Thom: I can carry it forward. OK. There's anything else I can do with it. Just days carry it forward to offset future gains.

Jessica: You can well carry it forward to offset future gains.

Thom: But the key here is remember we're just sort of giving you general strategies. So this is part of the conversation that you should have with your tax advisor. To to to see exactly how does that work for you. Because the key here is that all of these strategies have to work for you even though they're good. So in order to do that you should have that conversation with your tax advisor right. So that's great. So we've talked about midterm savings and you know the key thing about midterm savings of course is that you've got a lot more sort of flexibility here in how you invest it. So in order to save effectively for your mid-term goals or some guidelines that you should be paying attention to. So the first one is to make sure that you know what your goal is and what the timing is of that goal and to match up the way that you save for it with the timing of when you're going to need that. The second guideline is to adjust the risk by moving to more conservative investments like from stocks to bonds as you get closer to that goal.

Thom: And then the third guideline is to manage those taxes and there's a couple of strategies that we talked about there. Key one is is knowing the difference between income and capital gains because capital gains are taxed at a more favorable rate. Another one is to know when you want to harvest losses so they can use that to offset gains so that you can actually you know enjoy some of the gains without having to pay taxes on it. Now we're going to talk about long term savings thing about long term savings is that there is a lot of tools out there that are available to us a lot more than we have with the midterm or the short term it gives us a lot of advantages. It gives us a lot of flexibility but it also also adds a lot of complexity to everything that we're doing. So let's just talk about long term savings and what do we mean by long term savings? You know what. What are some examples of that?

Jessica: Sure so long term savings typically are something that you're saving for in 10 years or more so financial independence. Or as others term at retirement. We tend to think about it as financial independence.

Thom: Yeah that's sort of an interesting term and maybe where I just talk about that for a moment here because you know the concept of retirement which really started in the 1930s as a way to get older people out of the workforce so they can get younger people into the workforce. You know it sort of took on this idea that you reach a certain age typically age 65 which was also somewhat arbitrarily picked. And then I'll send you just quit working and you live you know get to collect your gold watch and live on your pension which many people don't have any longer. Or your own savings on that but that's not what we see people wanting to do any longer. Instead we often see people that are happy to keep working they really enjoy their job or maybe they want to work at a different job and maybe not make as much money. So we don't talk so much about financial independence as we do talking about the idea that you're going to work because you're having fun not because you have to make money. So that's kind of a key part of long term savings.

Jessica: Another example would be saving for your kid's college education.

Thom: Yeah we just got finished doing a plan for some people who've you know just have a newborn right now and they're already talking about wanting to save when they're planning on having another one here in a couple of years. And you know they're talking about saving for that. So that's you know 18 years. That's long term.

Jessica: That's yeah that's true. Yeah. When you're looking that far out.

Thom: So you know the thing about saving for it is that we've got all of these tools that have some strange names to them things like 401k 403b 457 529 IRAs Sep IRAs inherited IRAs Roth IRAs. You know the list can go on and it certainly gets confusing and it gets confusing because a lot of those all of those with numbers actually refer to sections of the IRS code which is why they have those kind of bizarre numbers to them. But some of these are more common than others. Most people have a 401k they might know what an IRA is. You might know what a Roth IRA is. But what sort of a common what are the common characteristics of these?f these?

Jessica: Sure. Well all of these types of savings accounts have tax breaks.

Thom: Ok so what do you mean by tax breaks.

Jessica: Yeah OK. So. So your 401k. Let's say you you work for an employer and they have a 401k so that's employer sponsored retirement plan and you get paid. And let's say you put 3 percent into your your 401k. That money goes into the account without being taxed. And it will grow tax free. So these different types of savings accounts that are specifically for retirement or financial independence. The 401k an IRA. So that stands for individual retirement account. And that one that you you're free to open that on your own. Your employer has no control over that. You're able to do that and what it is it's a it's kind of like a basket that keeps stocks and bonds in it. And it's it's not an investment itself at all for those that might. I mean that might not know. Yeah. It's the V. It's the tool the tool that holds the stocks and the bonds. So for example for an IRA you could use that to consolidate old 401ks's if you have a couple of different 401k's that at various employers you can use your IRA to consolidate those or if you don't have a retirement plan through your work you could open up an IRA and save money for financial independence that way. And again why why we are talking about these are because they have these tax advantages.

Thom: And they're good for long term savings. So yeah. So this does get a little confusing. So let's let's kind of make sure we can clarify this because we really would like it if you could get out of here and have a conversation about these things and be able to the real test here is go and talk to your partner and explain what these things are. If you can do that then we're doing great. So 401k is always provided by your employer. It's not something that you can just do yourself as opposed to an IRA. The first word in there is individual and that means that it belongs just to you. Now each one of them has different rules and different restrictions and that gets where the complexity is. But don't worry about that right now. The other thing that you often hear about is a Roth IRA. And that sounds a little confusing but how does a Roth IRA differ from a regular IRA.

Jessica: So the Roth IRA is very similar to an IRA as as Thom said you it's it you own it. It's it's individual but the differences when when you pay the taxes so you would contribute money to a Roth IRA. After paying taxes.

Thom: So it's the money you've already paid tax on it goes into a Roth IRA as opposed to a regular IRA. The money you put in is money you haven't paid tax on it.

Jessica: Exactly. So for a Roth IRA you're paying the taxes on the front end and for a regular traditional IRA. It's on the back end when you're taking the money out. That's when you pay the taxes.

Thom: But with a Roth IRA you don't pay tax when you take the money out. That's a good deal.

Jessica: Well it is a good deal it depends for both of them they're good deals. It depends what tax bracket you're in for both situations when you're contributing and when you're withdrawing so those are considerations.

Thom: So just sort of an idea here. That's just as I mentioned there's a whole bunch of these different things and it gets complicated to do all. So let's just focus on kind of the big ones that most people have like a 401k an IRA and a Roth IRA. When do you use these.

Jessica: So a 401k. That would be provided by your employer. So if you do work for a firm that has that benefit then you can take advantage of that. If you don't then can open up an IRA or a Roth IRA. Definitely if there is a company match that makes sense for the 401k to make sure that you're at least investing in the match. So then if you would like to save even more money you can you can you also have the option to save an IRA or a Roth IRA. And so one of the considerations are if you're going to be in a lower tax bracket currently vs. when you're in financial independence and that can kind of help you determine if you should be using the Roth or the traditional IRA.

Thom: Yeah and something else that's important to remember here is we're talking about tax benefits to this and there are also restrictions around how much you can put in when you can contribute whether or not you even can can contribute say to an IRA or a Roth IRA. So I want to emphasize that what we're trying to do here is just give you the tools that you need so that you can go and talk to your tax adviser your accountant CPA if you're using a CPA Enrolled Agent whoever it is that helps you prepare your taxes. Talk to them so that you know you know what's really available to you and what are the tax advantages that apply specifically to you because your situation is going to be a bit unique.

Jessica: Right. And some of the tax advantages are specifically with for one case the Roth IRAs and the traditional IRAs. Is that the earnings they grow tax free. You don't have to pay capital gains on the earnings. Additionally for the 401k in the IRA those are considered tax deferred accounts. So the contributions that you're contributing are pre-tax or you pay the income tax when you withdraw the money.

Thom: So yeah we talk about being tax advantaged and there's a term here that is probably helpful to use. You know we try to avoid using the language of the financial industry here but sometimes some of that language is really helpful so we can talk about qualified accounts and non qualified accounts suggesting maybe you can give us and I just sort of a definition what's a qualified account what's a non qualified account.

Jessica: So a qualified account would be anything or an account that has a tax advantage. So as we discussed four 401k IRAs those types of accounts have tax advantages a non qualified account would be just your savings account something as simple as that would be one that doesn't have a tax advantage and the tax on any capital gains would be owed in the year that it occurs.

Thom: Ok so the difference is with a qualified account you don't pay tax now you pay tax at some future date because that's the tax advantage of it or or it grows without any without having to pay any tax at all in the case of a Roth IRA. But a non qualified account you're going to pay taxes as the income or the capital gains are earned. All right. All right. So that's that's kind of helpful. So it sounds like with these tax advantages that means the government is giving you something they're giving you a break on the taxes and it's sort of been my experience that when the government gives you something the government take something away.

Jessica: There are some restrictions. I mean that I think the government does want to incentivize us to to to save but there are these restrictions and we mentioned the magic age of fifty nine and a half. So that is one of the restrictions to be considered for these 401ks IRAs Roth IRAs.

Thom: So what happens at 59 and a half.

Jessica: They just pick that year.

Thom: Yeah I know. That's why I know it's sort of an arbitrary I guess. Use. Fifty nine and a half. Who thinks of that. But what happens.

Jessica: You can take your money out prior to that. We don't encourage that because you're going to have a penalty. And so there's better ways to save money. There are better tools out there to save money. If you are going to need the money prior to turning fifty nine and a half. But if you think you're not going to need the money till after you turn fifty nine and a half. These tools are great ways to save.

Thom: So the penalty goes away after age fifty nine and a half.

Jessica: Exactly.

Thom: Ok. So there was another sort of magic age that I've heard about too and it's 70 and a half half year again seven and a half. So what happens at 70 and a half.

Jessica: So at 70 and a half there are required minimum distributions so that's RMD or required minimum distributions. So those are.

Thom: What does that mean.

Jessica: Right. Yes. As we talked about your IRA is a tax advantaged account and you don't pay taxes when you contribute the money. Well the government wants their money eventually. So this is giving their their money back. So once you turn 70 and a half they're requiring you to withdrawal a portion of that account so that when that money is withdrawn it's taxed at ordinary income rates. Now one thing Roth IRA raise do not have required minimum distributions.

Thom: So I could put money into a Roth and I could just let it sit there forever. So my kids could inherit my Roth IRA.

Jessica: Yes that's correct.

Thom: Are they going. Are they going to pay tax on it when they inherited.

Jessica: Unless there's a state taxes. But no. No. Yeah. As far as ordinary income tax. No because the audit.

Thom: Ok so that tax just goes away completely. Yeah. OK.

Jessica: You paid the taxes on the front end for the Roth IRA. Other things to consider for the restrictions are there are caps on the amount of money that you can contribute or contribution limits. So for an IRA or a Roth IRA the amount that you can contribute is is six thousand a year. Currently today as of today.

Thom: That changes every year doesn't it.

Jessica: It does it does it does. And if you're 50 or over you can contribute another thousand so seven thousand a year.

Thom: So there's advantages to getting old.

Jessica: They called the catch up contribution but yeah. So just so just being aware of that because there is a penalty of course if you contribute more than the limit. So each year. Just be aware that there there is this limit and it does change. And just good to talk to a financial advisor about her or an accountant. And for your 401ks there is a limit as well. So that's nineteen thousand a year. And if you're over 50 the limits. Twenty five thousand.

Thom: We keep talking a lot about it and realize that again. Yeah we've given you a lot of technical details here and there. And that's the thing about these long term savings plans is that they can be very technical. So let me see if I can kind of sum it up in a way that kind of hits on the key things that you need to be aware of. First of all when you take advantage of any one of these savings plans that have these bizarre names to them that there are certain tax advantages that come with that in the primary tax advantages are that the money that you put in. In most cases is money that you don't pay tax on as that money grows. You don't pay tax on the earnings. You don't pay any tax until you take the money out and you spend it. Now you know there's always a complicating factor in here that exception to the rule and that's where Roth IRAs come in because they're the flip side of that with Roth IRAs you put money and you've already pay tax on. But you're never gonna pay tax on it again and you're not going to pay tax on the earnings. You know there are some restrictions on when you can take it out but when you do you don't have to pay tax on it. So that's really the big advantage. And because you have those advantages we call that a qualified account with non qualified account you don't have those tax advantages you pay tax on the earnings in on the capital gains in the year in which you receive those.

Thom: So that's that's the other key thing is the difference between a qualified and non qualified as we pointed out where the government gives you something the government takes something away and what they do is they place restrictions on these. So in the case of say a 401k or an IRA if you take money out before age fifty nine and a half you're going to pay a 10 percent penalty on it. So think about that for a moment if you wanted to take money out of your IRA to go on vacation and you're in a 30 percent tax bracket you're going to pay a 30 percent tax plus you're going to pay a 10 percent penalty so it's going to cost you 40 percent of that money to take it out. That's tremendous erosion. So you just don't want to do that. That's why we talk about this as being long term savings and why it's important to understand what you're saving for. So if you're saving for retirement you want to put it into these types of plans. If you're saving for a vacation you don't want to put it into these types of plans. It's pretty much really that simple. As a result of the fact that we do have these restrictions around these investments then it also means that we have some special management needs some of them actually can work to your advantage. So what we want to talk about now are what some of these special management needs are. And Jessica what did you kind of address that topic.

Jessica: Sure. So the first special management need is the restricted number of investments. So let's say you have a 401k there usually is a list of different funds that you can invest that money in. Whereas in an IRA or a Roth IRA typically you have a little bit more flexibility in how you can invest that money.

Thom: So let me just interject here for a moment when we talk about the other number of funds we're talking about mutual funds that are in there. And I just want to point out that a lot of these have what are referred to as target date funds and in fact I just had this conversation with my niece she started a new job and the company she works for have they automatically enroll you at 3 percent into their 401k. You have to opt out if you don't want to participate in that. And then what they do is they automatically put them into what's called a target 2060 fund. And what that says is they assume you're going to retire in the year 2060 and so they split the money between how much they put in stocks and how much they put in bonds based on how long you have towards retirement. So in this case you'd have a lot more in stocks and bonds. The problem with that is really two part one is it doesn't really address your unique situation. And the second one is that they assume that you're going to take all your money out when you retire at age 65. And the reality is that most people when they retire at 65 have 20 to 30 years left so they need to make that money last. So it gets too conservative. So we're not a big fan of that just so that you're kind of aware of it but that's what we're talking about when we talk about funds.

Jessica: Another one of those special management needs is where the money is invested. So if it's invested in a 401k or an IRA vs. a non qualified account like a savings account or a brokerage account you want to generate income inside of the 401ks and the IRAs because the income that's generated it's it's taxed at a higher rate. So this income could be interest from bonds or dividends from stocks whereas for non qualified accounts you want to generate capital gains because that is is taxed at a lower rate and you don't have those tax advantages.

Thom: I mean that's that's a really good point because this is part of the tax management that we had talked about before. That's one of the nice things about long term savings is that you have this opportunity to to manage your taxes a little bit better. So that's great. So let's just kind of wrap this up a little bit. You know we've talked about long term savings. And again you know one of the things that we didn't talk about the most worth mentioning is that when you have long term savings you can certainly take on more risk as well. So you know if you're a 35 year old and you've got at least 30 years before you're going to be anticipate you're going to hit financial independence then you can afford to have more money in stocks less money and bonds and because you're going to have the ups and downs on that. But history tells us that when the market takes a nosedive it comes back again. Usually fairly quickly and it continues to grow so the long term trend for stock investing is up even though there's a lot of dips in between you can whether those dips when you have more time. So that's that's one of the big advantages of that.

Jessica: And then one other thing that we didn't get to mention with was special management needs is being aware of the money that you are saving in your 401ks and IRAs versus what you're saving in your non qualified accounts. So we recommend the clients to not save everything for your financial independence in these qualified accounts in these 401ks and IRAs because as Thom mentioned earlier you're paying that 30 percent tax potentially when you withdraw the money. Where we see this come into play is let's say a client wants to take a big trip and they want 20000 to take a cruise in the Mediterranean. And we find that one strategy that works well is if they pull that money out of a brokerage account or a Roth IRA a that that is a better strategy than pulling it out of their IRA. Because the IRA again if you're paying that tax and then also it counts towards your ordinary income.

Thom: Again you're matching up your savings with them when you're going to want that when you're going to want that money. So that's the key there. Right. So summing this all up you know we've got these saving strategies that have sort of these strange names to them but they're ones that are very good for long term savings because you do have the tax advantages and if you don't have that extra burden of having to pay taxes you keep going the money can grow quicker and you can have more money available for you when you do hit your financial independence. There are certain restrictions that are involved in that because of the tax advantages that are there and there are also certain management restrictions as well. So we've covered a lot. We've talked about common mistakes that people make. We've talked about how to avoid those with your short term savings with your midterm savings and with your long term savings. Jessica has been a really great guest and we've happy to have you on here and thank you for sharing a lot of what you've learned as well as a lot of your personal stories.

Jessica: Yeah. Thanks for having me.

Thom: So what we'd like you to do now is go to FinancialWheel.net where you can hear a transcript of this and the other podcast. You can put your questions on there which would be great. There's a chance for you to kind of test the waters a little bit. Just click on that. We'll let you figure out exactly what that means but I think you'll find that really interesting. And we look forward to having you come to our next podcast. We're going to get away from a lot more of these technical spoke conversations that we've been having. You might recall that we have hub conversations spoke conversations and tire conversations. And we're going to talk a little bit more really about a hub conversation where my guest will be Leonora Edwards. Leonora helps small businesses with their marketing. She has a lot of experience in working with small business owners. And with this whole idea of kind of creating a life balance so that'll be our next podcast. We'll look forward to having you join us. In the meantime keep your conversations positive and constructive.

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      Financial Satisfaction Survey


      Directions: The statements below will help you to think about and assess how satisfied you are with many aspects of your financial life. Indicate your level of satisfaction for each statement with stars.
      (1 star = "Not Satisfied", 3 stars = "Moderately Satisfied", 5 stars = "Very Satisfied")

      I am satisfied with...

      1. ...with my ability to meet my financial obligations

      2. ...with the income my current job or career provides me.

      3. ...with my spending habits.

      4. ...with the level of debt I carry.

      5. ...with the “extras” that I am able to buy for myself and/or loved ones.

      6. ...with the level and quality of insurance protection I currently have.

      7. ...with the amount of money that I save and invest on a regular basis.

      8. ...with my current investment choices.

      9. ...that I am on track to build a sufficient retirement nest egg.

      10. ...with the level of employee benefits I receive.

      11. ...with my style of personal bookkeeping and financial record management.

      12. ...with my ability to provide financial help to family members.

      13. ...with my estate plan.

      14. ...with my level of charitable giving.

      15. ...with the level of financial education I have attained.

      16. ...with how I respond emotionally to my personal finance issues.

      17. ...with my ability to communicate about my financial matters.

      18. ...with the feelings I have about my money life.

      19. ...that financial issues do not cause stress or strain in the relationships that are important to me.

      20. ...with the working relationships I have with my financial service providers (i.e., insurance agent, banker, broker, financial planner, accountant).

      © 2002 - 2018 Money Quotient, Inc. All Rights Reserved. This document is available via licensing arrangements with Money Quotient and is protected by federal copyright law. No unauthorized copying, adaptation, distribution, or display is permitted - moneyquotient.org.

      Life Transition Survey


      Directions: In each section, select the transitions that you are currently experiencing and those you are likely to experience in the future. In addition, check transitions in the short to mid-term and long-term columns that you either hope to experience or anticipate with concern.

      Work Life Transitions

      1. Change in career path:

      2. New Job:

      3. Promotion

      4. Job loss

      5. Job restructure

      6. Education / retraining

      7. Sell or close business

      8. Transfer family business

      9. Gain a business partner:

      10. Lose a business partner:

      11. Downshift / simplify work life

      12. Sabbatical / leave of absence

      13. Start or purchase a business

      14. Retire:

      15. Phase into retirement

      16. Other

      Financial Life Transitions

      1. Purchase a home:

      2. Sell a home:

      3. Relocate:

      4. Purchase a vacation home / timeshare:

      5. Re-evaluate investment philosophy:

      6. Experience investment gain:

      7. Experience investment loss:

      8. Debt concerns:

      9. Consider investment opportunity:

      10. Receive inheritance or financial windfall:

      11. Sell assets:

      12. Other:

      Family Life Transitions

      1. Change in marital status (marriage):

      2. Change in marital status (divorce):

      3. Change in marital status (widowhood):

      4. Expecting or adopting a child:

      5. Hire child care:

      6. Child entering adolescence:

      7. Child with special needs:

      8. Child w/pre-college expenses:

      9. Child going to college:

      10. Child getting married:

      11. Empty nest:

      12. Family special event (Bat/Bar Mitzvah, anniversary party, trip):

      13. Helping and/or gifting grandchildren

      14. Concern about aging parent

      15. Concern about health of spouse/partner or child:

      Legacy Life Transitions

      1. Increase charitable giving:

      2. Give special financial gifts to children/grandchildren:

      3. Give parental pension (monthly stipend):

      © 2002 - 2018 Money Quotient, Inc. All Rights Reserved. This document is available via licensing arrangements with Money Quotient and is protected by federal copyright law. No unauthorized copying, adaptation, distribution, or display is permitted - moneyquotient.org.