How to Avoid Your Own Personal Financial Crisis
Posted by main on July 6th, 2015
How to Avoid Your Own Personal Financial Crisis
While global financial crises are far beyond our individual control, it’s important to recognize that each of us is empowered to take control of our own personal financial future. One way to begin is by recognizing that there’s a lot of risk and uncertainty out there, and that planning to help mitigate risk and deal with uncertainty can go a long way toward keeping our personal financial goals on track.
Despite what seem to be uncontrollable economic forces, there are plenty of actions that can be taken today to incorporate “risk mitigation” into your financial decisions, to avoid having a personal financial meltdown.
From a financial perspective, consider some of the more common risks everyone faces:
- Longevity Risk – Outliving your ability to support yourself and your family financially.
- Mortality Risk – Dying without properly protecting your family, your business or your assets.
- Health Risk – Having to pay for a costly long-term illness, whether it’s your own, or the illness of a close family member.
- Credit Risk – Not being able to borrow to grow your business or facilitate personal capital expenditures.
- Market Risk – Not being able to sell your business or other important assets for their fair market value.
- Inflation Risk – Having the cost of goods and services go up, especially after retirement.
- Creditor Risk – Having lawsuits and/or bankruptcy potentially erode your life savings.
- Income Tax Rate Risk – The chance that income tax rates will increase, just when you need to draw down income-taxable retirement assets.
Obviously, any one of these risks could significantly impact your ability to keep your financial plans on track. However, a combination of these risks can be even more devastating. Imagine the outcome to the owner of a business who is about to retire if the market value of the business were to decline, the income tax cost of taking retirement distributions were to rise and inflation hikes were to make everything more and more expensive.
Now is the Time to Consider Taking Action
What combinations of risk keep you up at night? Whatever your answer, now is the time to consider taking protective action to help mitigate the risks that could upset your plans for tomorrow.
Let’s look at two hypothetical scenarios:
If you have pre-tax money invested in tax-qualified retirement savings and believe there’s a strong possibility marginal income tax rates will go up in the future for you, consider one or more of the following:
Today: Diversify your retirement savings by using techniques and financial products that provide tax-favored retirement distributions and/or risk mitigation options, such as a Roth IRA or Roth 401(k), Life Insurance and Annuities.
At Retirement: To the extent possible, match future taxable retirement plan distributions with future personal and/or business income tax deductions to potentially create at least a partial tax offset.
If however, tax rates are high today and you believe they will be lower for you at the time retirement income is needed: Maximize contributions to your tax-qualified retirement savings plan, thus creating larger income tax exclusions or deductions for those contributions at the higher tax bracket.
If you are a business owner, it’s possible the value of your business will be a significant component of your future retirement income. If you believe it may be difficult for you to sell your business for its fair market value when you retire, consider one or more of the following:
- Establish a funded buy-sell arrangement between you and your current business partners, key employees or even competitors. This will allow you to establish a value (by formula or otherwise) and a buyer today for a sale that may occur many years from now.
- Create a leveraged Employee Stock Ownership Plan (ESOP). In addition to providing benefits to eligible participants, this will allow you to sell your stock to your employees on a tax-advantaged basis during your working years and at retirement
- Take on an associate or junior partner to create a natural buyer. You may want to consider your children or other family members, even if they’re not yet ready (or you’re not yet ready to make the transition). With proper planning, family business succession arrangements can work out well for everyone concerned.
Being aware of the risks that impact you the most is a critical first step to risk mitigation. Next, identify your financial goals and objectives. Without clearly defined financial goals, opportunities you can take advantage of are much more difficult to recognize or implement. Of course, implementing an action plan to counter the risks you uncover is just as important, which is why it’s important to work with financial, tax and legal advisors to help ensure that even in times of economic uncertainty, you’re making certain your financial goals stay on track.
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