You CAN Invest in a Taxable Account

I spend a lot of time talking about retirement accounts, and for many Americans, the only stocks they will ever own are in their 401(k) and IRAs. I don’t know why, but many have never even considered investing outside of a retirement account, and a few have even thought it was not possible.

It is a GREAT idea to invest outside of your retirement accounts. Why? Because the contribution limits are so low for IRAs ($5,500) and 401(k) accounts ($18,500). There are a lot of people who put in that amount and then think they can’t do any more investing or that they don’t need to. There’s nothing magical about these amounts. No one is promised that if you save $5,500 a year into an IRA that you will have enough to retire (especially if you are getting a late start). And if you have ambitions to be wealthy, it may take you 30 or 40 years of 401(k) contributions to break the $1 million mark.

While we often talk about the tax benefits of retirement contributions, let’s actually run through the math of an IRA investment and making the same investment in a taxable account. The results may surprise you.

Let’s say you put in $5,000 to a Traditional IRA this year and also deposit $5,000 into a taxable account. In each account, you buy the same investment, such as a S&P 500 ETF, and hold it for 20 years until retirement. Assuming you get an 8% annualized return for those 20 years, in both accounts, your position would have grown to $23,304.79.

At the 20 year mark you withdraw both accounts. What taxes are due?

From the Traditional IRA, the entire withdrawal is treated as ordinary income. You may be in the 24% tax bracket, in which case you would owe $5,593.15 in taxes. That’s pretty painful and the reason why so many retirees hate taking money out of their IRAs and limit their withdrawals to their Required Minimum Distributions.

What about for the taxable account? You started with a $5,000 cost basis, so your taxable gain is $18,304.79. It is a long-term capital gain (more than one year), and will be taxed at the capital gains rate of 15%. Your tax due is $2,745.72. That’s less than half of the tax you’d pay on the withdrawal from the retirement account that you did for the “tax benefit”. Is that IRA a scam?

No, because you also got an upfront tax deduction for the IRA contribution. If you were in the 24% bracket, you would have saved $1,200 in taxes for making that $5,000 contribution. If you subtract the $1,200 in tax savings from $5,593, you still see that your net taxes paid was quite high: $4,393.

However, that is ignoring the time value of money and getting to save that $1,200 now. If you actually invest the $1,200 you saved that year, and have it grow at 8% for 20 years, guess what it grows to? $5593.15. (If you invested this in a retirement account, you will owe 24% in taxes on this gain, or another $1342.)

The key to coming out ahead with doing an IRA versus a taxable account is that you need to actually invest the tax savings you receive in year one. If you just consume that tax savings, instead of saving it, you actually might have been better off instead doing the taxable account where you could receive the lower capital gains rate.

The best solution is to maximize your retirement accounts AND save in a taxable account. If you want to become a millionaire in 10 years, save $5,466 a month. People have ambitious finish lines, but don’t set savings goals that are in line and realistic with their goals. The short-term activity has to match the long-term objectives. Once you are in retirement, it is a great benefit to have different types of accounts – IRAs, Roth, and taxable – to manage your tax liability.

My point is: Don’t be afraid of a taxable account. Retirement accounts are good, but mainly if you are going to save the upfront tax benefit you receive! Today’s ETFs are very tax efficient. While you will likely have dividend distributions of about two percent a year in a US equity ETF, when you reinvest those dividends, you are also increasing your cost basis. If you’re looking to invest in both a retirement and taxable account, let’s talk about how you can do this in the most effective way possible.

Specified Service Professions and the QBI Deduction

This year, there is a new 20% tax deduction for self-employed individuals and pass through entities, commonly called the QBI (Qualified Business Income) deduction, officially IRC Section 199A. While most people who file schedule C will be eligible for this deduction, high earners – those making over $157,500 single or $315,000 married – will see this deduction phased out to zero, if they are in a Specified Service Trade or Business (SSTB).

See: FAQs: New 20% Pass-Through Tax Deduction

Professions that are considered an SSTB include health, law, accounting, athletics, performing arts, and any company whose principal asset is the skill or reputation of one or more of its employees. That’s pretty broad.

Some business owners may have income that is from an SSTB and other income which is not. For example, consider an eye doctor who has a business manufacturing glasses. If she performs an eye exam, clearly she is working in an SSTB as a health professional. If she is manufacturing glasses, that might be a different industry.

This possibility of splitting up income into different streams has occupied many accountants this year, to enable business owners to qualify for the QBI deduction for their non-SSTB income. Since this is a brand new deduction for 2018, this is uncharted territory for taxpayers and financial professionals.

In August, the IRS posted new rules which will greatly limit your ability to carve off income away from an SSTB. Here are some of the details:

  • If an entity has revenue of under $25 million, and received 10% or more of its revenue from an SSTB, then the entire entity is considered an SSTB. If their revenue is over $25 million, the threshold is 5%
  • An endorsement (by a performing artist, for example), or use of your name, likeness, signature, trademark, voice, etc., shall not be considered a separate profession. If you are in an SSTB, an endorsement shall also be considered part of the SSTB.
  • 80/50 rule. If a company shares 50% or more ownership with an SSTB, and receives at least 80% of its revenue from that SSTB, it will be considered part of the SSTB. So, if our eye doctor who makes glasses only makes glasses for her own practice, then it will be considered part of her SSTB. If the manufacturing business has at least 21% in revenue from other buyers, then it could be considered a separate entity and qualify for the QBI deduction.

Business owners in the top tax bracket of 37% for 2018 (making over $500,000 single or $600,000 married), might be considering forming a C-corporation if they are running into issues with the SSTB. While a C-Corp is not eligible for the QBI deduction, the federal income tax rate for a C-Corp has been lowered to a flat 21% this year.

Of course, the challenge with a C-Corp is the potential for double taxation: the company pays 21% tax on its earnings, and then the dividend paid to the owner may be taxed again from 15% to 23.8% (including the 3.8% Medicare surtax on Net Investment Income.)

Still, there may be some benefits to a C-corp versus a pass-through entity, including the ability to retain profits, being able to deduct state and local taxes without the $10,000 cap, or the ability to deduct charitable donations without itemizing.

If you have questions about the QBI Deduction, the Specified Service Business definition, or other self-employment tax issues, we can help you understand the new rules. We want to help you keep as much of your money as possible, but you can’t wait until next April and then hope you can do something about 2018.

Financial Planning In Your Sixties

Investors in their sixties are in a decade of decisions. Up to this decade, you could do very well by putting your saving on autopilot, and doing little more for your portfolio than occasionally rebalancing it. Now, you’re faced with some important decisions, whether you are planning to retire soon or to wait many years down the road.

See: Six Steps at Age 60

1. Social Security. The decision of when to start receiving your Social Security benefits is independent from when you retire from your job. The Full Retirement Age (FRA) today is 66, but you can start early benefits from age 62 on. Or you can delay past FRA, all the way to age 70, and receive an 8% annual increase in benefits for waiting.

Where else can you get a guaranteed 8% increase in benefits? It’s a great deal to wait, even if it requires that you spend down some of your cash. Guaranteed benefits are the best way to offset longevity risk, so maximizing your Social Security can be a great idea if you are healthy and have a family history of long lives. For married couples, there is a survivor’s benefit, which means that the spouse with the higher benefit has essentially a joint benefit. There are a lot of things which people don’t consider about Social Security, and that’s why it’s best to talk to me first.

See: Social Security, It Pays to Wait
See: Guaranteed Income Increases Retirement Satisfaction
See: Social Security Planning: Marriage, Divorce, and Survivors

2. Health Care. Medicare starts at age 6r5. If you retire before 65, you will have to figure out how you will be covered until age 65. And when you do reach age 65, you will sign up for part A, and probably Part B (unless you have proof of employer coverage), and will then need to consider whether a Medicare Supplement or Advantage plan makes sense for you. Again, lots of decisions here, and if you don’t sign up at your “window” at age 65, you may have to pay permanent penalties on Part B when you do enroll.

See: Types of Medicare Health Plans

3. Retirement Age. The most dangerous thing I can hear is “It’s okay, I don’t plan to retire.” There are so many people in their sixties who planned to work for another decade or more and things didn’t work out as planned. Maybe they were laid off, or had a health situation, or their spouse had a health issue, or their employer asked them to relocate. Things change. We can’t assume that we have the ability to maintain the status quo indefinitely by choice. My goal for every sixty-something client is that you work because you want to and not because you have to. So even if your planned retirement age isn’t until sometime after 75, make sure you and your family will be all set financially if you decide to retire earlier.

See: How Much Income Do You Need In Retirement?

4. Withdrawal Strategies. If you are retiring and starting withdrawals from your accounts, you will need to make decisions about how much to withdraw and from which account or assets. If the market goes down, can you withdraw the same amount? What is the most tax efficient way to withdraw from your accounts?

See: Taxes and Retirement

5. Asset Allocation. We typically plan for a 20-30 year retirement period, so even if retirement is close, we are still investing for the long-term. Even so, we want to reduce market risk in the five years before retirement to mitigate the potential impact of a bear market right before you plan to begin withdrawals. After retirement has begun, there is evidence that it may be beneficial to sell your bonds first and not rebalance your portfolio. This would mean that your equity holdings would become a larger weighting in your allocation over time.

See: What Is The Best Way To Take Retirement Withdrawals?

Of course, there are many other decisions which we evaluate in a financial plan, such as whether to take a pension or a lump sum upon retirement. When you are facing these decisions, what you don’t know can hurt you. That’s where I can help you navigate these decisions whether you have already retired, are retiring soon, or have many years before you plan to retire.

How to Get Paid for Limit Orders

When we place an order for a stock or Exchange Traded Fund (ETF), there are a couple of ways we can make a purchase. The easiest is a Market Order, which simply instructs our custodian (TD Ameritrade Institutional) to purchase the specified number of shares at the current market price.

Sometimes, however, we may want to purchase shares at a lower price or wait until the market falls to a specific level. This can be achieved through a Limit Order – which says that we will buy our position only at or below a price we indicate. Of course, the challenge with a Limit Order is that there is no guarantee that the price will in fact fall to our target!

Many investors who use Limit Orders, especially in a Bull Market like we’ve had in recent years, see prices move up and their orders never fill. Then they are faced with the ugly choice of having to buy at a higher price than if they had just used a Market Order at the beginning. And instead of participating in the growth of the market, they sit on the sidelines in cash. So there can be a real opportunity cost to Limit Orders. In reality, Limit Orders are a type of market timing, where an investor thinks they can predict short term moves and profit from those fluctuations.

There is a third, more complicated option, which most investors don’t know how to do. Like a Limit Order, we can select a target price that we would like buy a stock or ETF within a certain time frame. And like a Limit Order, if the price falls to or below this level, we will buy the shares at our target price. Unlike a Limit Order, we can get paid for our willingness to buy these shares, regardless of whether or not the order fills, by using options.

It is done by selling a Put. A Put is an option which requires you to buy a security for a specific price (called the “strike price”) before or at the expiration of the option (typically one month to one year). When you sell a Put, you receive a premium upfront in exchange for agreeing to buy shares at the strike price. One options contract equals 100 shares.

Let’s walk through an example. You are looking to buy the iShares Emerging Markets Index, ticker EEM. As of the Friday August 17 close, you could have bought EEM at the market at $42.21. 100 shares would have cost $4,221. But maybe you thought it could go lower, so instead, you enter a Limit Order for $40. Now, if EEM falls to $40, you will buy your 100 shares for $4,000.

Alternatively, you could sell a November $40 Put on EEM for $83. That means you would get paid $83 in exchange for the right for someone else to make you buy 100 shares of EEM for $40 a share between now and November 16, 90 days from now. If EEM falls to $40 or below, you will buy 100 shares for $4,000 just like in the limit order, plus you made the $83. Even if EEM stays above $40, you keep the $83 no matter what.

I know that $83 isn’t much, it represents about 2% of the price of EEM. That’s over 90 days, so if we consider the value of selling this option on an annualized basis, it is a bit over 8% a year. That’s a lot better than using a limit order and not making anything.

Let’s consider the difference between a market order, a limit order, and selling a Put using two different scenarios, at 100 shares. Today’s price is $42.21 and I’m disregarding commissions and taxes in these examples.

1. The price rises to $45. If you bought at the market ($4,221), you would have a profit of $279. If you placed a limit order at $40, your order never filled and you have nothing. If you sold the put, you would not have any shares, but you would have the $83.

2. The price of EEM falls over time to $38 a share. If you bought 100 shares at the market ($4,221), your shares are now worth $3,800 and you are down $421. If you set a limit order at $40, you would have bought 100 shares for $4,000 and you are now down by $200. If you sold a put, you’d also buy 100 shares at $4,000, but since you collected the $83, you now have a lesser loss of $117.

So whether the price goes up or down, selling a Put is generally going to be better than a limit order. The only example where this might not occur is if a stock has a big gap down overnight – for example, it is at $41 one day and the next morning opens at $38. In this case, your limit order will fill at the open at $38. This does happen sometimes, but it is fairly unusual. Most limit orders, if they fill, end up being executed right at your limit price.

Who is taking the other side of the option? The buyer of a Put is likely a “hedger”: they are buying the Put as protection to preserve their money in case the stock goes down. Or they are a speculator who is betting that the stock will fall. Both are bad bets, statistically. When the expected return of the market is only 8%, paying an 8% annualized premium to hedge your position is in effect giving away all of your potential upside.

Instead, I’d rather be the person selling them this insurance and be the seller of the Put. I’ve spent may years selling Puts (and Calls, too) and am not recommending this is something you try to do on your own. Not every stock or ETF has an active options market and you should be very careful with thinly traded options.

But this is a strategy we use with some of our clients in place of Limit Orders and I wanted to share with all of you an very brief overview of how it works. Please note that options are only available on securities which trade on the exchange and not on mutual funds. What I do not recommend is selling Puts as a speculative bet. Only sell Puts for shares you want to buy and own as a long-term investment. Additionally, to sell Puts, you must either have either cash in the account or a margin account. If you’re interested in learning more about selling Puts in place of limit orders, please reply to this email.

Note: accounts must be approved for options before trading can begin. Please see The Characteristics and Risks of Standardized Options for more information.

Increase Returns Without Increasing Your Risk

In theory, Return and Risk are linked – you cannot get a higher rate of return on an asset allocation without taking more risk. However, portfolios can be inefficient and there are a number of ways we can improve your return without adding risk or changing your asset allocation. Here are five ways to increase your returns:

1. Lower Expense Ratios. Many mutual funds offer different “share classes” with different expense ratios. The holdings are the same, but if one share class has 0.25% more in expenses, those shareholders will under perform by 0.25% a year. Here at Good Life Wealth Management, we have access to Institutional shares which have the lowest expense ratio. Generally, these funds are available only to institutions or individuals who invest over $1 million. We can buy these shares for our investors, without a minimum, which frequently offer savings of 0.25% or more versus “retail” share classes.

2. Increase your Cash Returns. If you have a significant amount of cash in your holdings, make sure you are getting a competitive return. Many banks are still paying 0% or close to zero, when we could be making 1.5% to 2% elsewhere.

3. Buy Treasury Bills. If you have a bond mutual fund and it charges 0.60%, that expense reduces your yield. If the bonds they own yield 2.8%, subtracting the expense ratio leaves you with an estimated return of 2.2%. Today, we can get that level of yield by buying Treasury Bills, such as the 26-week or 1-year Bill, which have a short duration and no credit risk. If you are in a high expense bond fund, especially a AAA-rated fund, it may be preferable to own Treasury bonds directly and cut out the mutual fund expenses. We participate in Treasury auctions to buy bonds for our clients.

4. Buy an Index Fund. If you have a large-cap mutual fund, how has it done compared to the S&P 500 Index over the past 5 and 10 years? According to the S&P Index Versus Active report, for the 10-years ended December 2017, 89.51% of all large-cap funds did worse than the S&P 500 Index. Keep your same allocation, replace actively managed funds with index funds, and there’s a good chance you will come out ahead over the long term.

5. Reduce Taxes. Two funds may have identical returns, but one may have much higher capital gains distributions, producing higher taxes for its shareholders. If you’re investing in a taxable account, take some time to look at the “tax-adjusted return” listed in Morningstar, under the “tax” tab, and not just the gross returns. Even better: stick with Exchange Traded Funds (ETFs) which typically have much lower or even zero capital gains distributions. This is where an 8% return of one fund can be better than an 8% return of another fund! We prefer to hold ETFs until we can achieve long-term capital gains, and especially want to avoid funds that distribute short-term gains. We also look to harvest losses annually, when they occur, to offset gains elsewhere.

How can we help you with your investment portfolio? We’d welcome the chance to discuss our approach and see if we would be a good fit with your goals.

The New 2018 Kiddie Tax

Last year’s Tax Cuts and Jobs Act (TCJA) significantly changed the way your dependent children are taxed. Previously, they used to be taxed at their parent’s tax rate, but starting this year, their income could be taxed at the egregious “Trust and Estate” rate of 37% with as little as $12,501 in taxable income. With higher deductions, other children will pay less tax in 2018. Both changes give rise to additional planning strategies that parents will want to know before potentially getting a nasty surprise next April when they file their next tax return.

First, let’s define dependent child for IRS purposes. A dependent child includes any child under 18, an 18 year old who does not provide more than 50% of their own support from earned income, or a full-time student who is under age 24 and also does not not provide more than 50% of their own support from earned income. A child’s age for the tax year is the age they are on December 31.

There are different tax methodologies for earned income (wages, salary, tips, etc.) versus unearned income (interest, dividends, capital gains, etc.) under the Kiddie Tax.

First, some good news, for Earned Income, the standard deduction has been increased to $12,000 for 2018, which greatly increases the amount of income a child can earn income tax-free. Of course, they will still be subject to payroll taxes (Social Security and Medicare) on these earnings.

Strategy 1. For Self-Employed Parents: did you know that when you hire your dependent children, you do not have to pay or withhold payroll taxes (Social Security and Medicare) on their income. If you hire them, and have legitimate work for them to do, you could shift $12,000 from your high tax rate to their 0% tax rate. If they open a Traditional IRA and contribute $5,500, they could earn $17,500 tax-free. Just be aware that the IRS scrutinizes these arrangements, so be prepared to demonstrate that the work was done and the pay was “reasonable”. (Paying your kids $500 an hour to mow the lawn might be considered excessive.)

For Unearned Income, the Kiddie Tax is more complicated. The standard deduction for unearned income is only $1,050 (or their earned income plus $350 up to the $12,000 maximum). Above this amount, the next $2,100 is taxed at the child’s rate, and then any unearned income above this level is now taxed at the Trust and Estates rate. If a child has a significant UTMA, inherited IRA, or other investment account, this is where their taxes could soar in 2018, especially if they used to be taxed at their parent’s rate, say, of 22%. If their parents were in the highest tax bracket, there would be no change, but for middle class kids with investment income, they now could be taxed at a much higher rate than their parents!

Here are the 2018 Trust and Estates Tax Marginal Rates, which now apply to the Kiddie Tax:
10% on income from $0 to $2,550
24% from $2,551 to $9,150
35% from $9,151 to $12,500
37% over $12,501

Long-Term Capital Gains and Qualified Dividends will be taxed at:
0% if from $0 to $2,600
15% if from $2,601 to $12,700
20% if over $12,701

2. Children with under $1,050 in income do not need to file a tax return.

3. The first $4,700 in long-term capital gains are at the 0% rate (a $2,100 deduction followed by $2,600 at the zero rate). This is an opportunity to gift appreciated shares to a child and then they will not owe any tax on the first $4,700 in capital gains. If you are planning to support your kids and set up a fund for them, or pay for college, why should you pay these taxes if they can be avoided? We can establish a program to make use of this annual 0% exclusion.

4. If a child’s investment income is subject to the Kiddie Tax, and the portfolio is going to be used for college education, a 529 Plan can offer tax-free growth and withdrawals for qualified higher educational expenses. In these cases, 529 Plans have just become more valuable for their tax savings.

5. For some college aged kids, it may be better for the parents to stop listing them as a dependent if eligible. In the past, parents received a personal exemption for each child ($4,050 in 2017), but this was eliminated by the TCJA. It was replaced with an expanded child tax credit of $2,000 in 2018. However, the tax credit only applies to children under 17. Unless you are able to claim a college tax credit, it is possible you are not getting any tax benefits for your college kids over 17. In this case, not claiming them as a dependent, and having your child file their own tax return, may allow them to receive the full standard deduction, save them from the Kiddie Tax, and may even allow them to qualify for the college credit. You would need to verify with your tax professional that your child did in fact have enough earned income to be considered independent.

College financial aid doesn’t exactly follow the IRS guidelines for dependency, and they don’t even ask if a parent lists a child as a dependent or not. Instead, the Free Application for Federal Student Aid (FAFSA), has its own form, Am I Dependent or Independent?, which looks at factors including age, degree program, military service, and marital status.

If you’ve got questions on how to best address the Kiddie Tax for your family, let’s talk.

Financial Planning In Your Fifties

My hope for every fifty-something investor is that you have by now attained financial independence, where you have enough assets to stop working if you wanted and live off your investments. Most aren’t quite there yet, but if you’re working with me, we have a good idea of your finish line, a quantifiable goal, and the steps needed to get there.

What does scare me is when someone says that they plan to never retire, so this doesn’t matter or apply to them. While it’s natural to wish that time would stand still or that things won’t change, it’s a poor plan to assume that change isn’t going to happen to your life.

I think of a relative who worked for one company for 30 years, until age 59, when they went out of business. He was used to making a certain level of income, which just wasn’t available in his small town, for someone with skills that didn’t easily carryover to other types of business. He was planning to work forever, but it turns out, he wasn’t interested in jobs that paid 50% of his previous salary. He was unemployed for three years, before starting Social Security at age 62.

See: The Boomer’s Guide to Surviving A Lay-Off

For many employees in their fifties and sixties, they want to keep working, but if they lose their job, they discover how tough it is to get another high-paying job in today’s economy. Others leave work due to health issues, or to care for an ailing spouse. The point is that things change. It’s great to work if you want to, but not because you have to. The single-minded goal of every fifty-something investor should be to build their nest egg to where they would be fine if they didn’t work.

1) Prepare your retirement finish line. What size nest egg should you have? At a 4% withdrawal rate, you need 25-times your annual needs. Need $50,000 in withdrawals? Your goal is $1.25 million. Are you there now? How much do you need to save to get there? And while you are at it, download your Social Security statement.

Why 3% withdrawals might be better for retiring early: Can You Retire In Your Fifties?

2) Increase your contributions to catch-up levels. In the calendar year that you turn fifty, you can now contribute an extra $1,000 to an IRA ($6,500 total), and an additional $6,000 to your 401(k) or 403(b) ($24,500 total for 2018). There’s also a $1,000 catch-up for Health Savings Accounts (HSA), but you have to be 55 for the HSA catch-up.

Learn about The Secret Way to Contribute $35,000 to a Roth IRA. 

3) While it’s possible to manage debt into retirement, most people are more confident about their finances when they are debt-free before they retire. I’d suggest you avoid creating new debt in your fifties and consider paying your mortgage off entirely.

4) Many of us are going to need some type of long-term care in the future, especially as life expectancy rises with medical advances. Increasingly, in-home care can allow people in their eighties to remain in their home. Why are we talking about this now? The most cost effective time to buy long-term care insurance is in your fifties to early sixties. You can’t wait until you have a need for care, and then apply for insurance. Instead, we ought to look at creating a pool of funds that could provide this care should you or your spouse need it, decades in the future.

5) Rethink Retirement. Some of you will have a traditional retirement, where one day you stop working and never work another day. However, many of you will have a very different “retirement” than your parents. Maybe you change careers, go to part-time, start a business, or find new sources of income. It’s all possible! Let’s figure out how to make it happen.

See: Replacing Retirement With Work-Life Balance.

Financial Planning In Your Forties

In your forties, it’s time to get serious about your money. Let’s take care of business and establish your financial plan. You can create your future. When I meet with people in their sixties, their net worth and retirement preparedness has little to do with their income, but has a lot to do with how consistent they were with their planning and saving in their thirties and forties. So, be the 40 year old that will make your 65 year old self proud.

1. You are behind. Chances are that you have neglected some aspects of your financial planning at this point and many people in their forties are not on a trajectory that will lead to a comfortable future. Some people are only a little behind and just need to add a few things, but others are severely in danger. You still have the potential for significant compounding of your investments so take advantage of the fact that time is on your side.

Here’s a checklist of what you should have:

  • savings plan of how much to save and where;
  • a retirement plan that calculates a finish line when you can retire;
  • an estate plan;
  • a college funding plan for your kids;
  • comprehensive insurance for your assets, life, and for unexpected liabilities;
    tax strategies to minimize your tax bills;
  • a disciplined, investment program and target asset allocation.

Catch up: Financial Planning In Your Twenties
Financial Planning In Your Thirties

2. Get Rid of Debt. At this point, you should have a mortgage as your only debt. You should have paid off your student loans, and should be paying your credit cards in full every month. “Living within your means” means you don’t borrow money for furnishings, vacations, or toys.

If you are serious about your financial future, you will recognize that cars are a terrible waste of money. All cars lose about 50% of their value within five years. I see a lot of people who are leasing a Mercedes or driving a new $65,000 truck who tell me they cannot afford to put $400 a month into an IRA. My advice: keep your current car for as long as possible, 100,000 miles or more, then buy used and pay cash.

See: Rethink Your Car Expenses
Should You Get A New Car to Save Gas?

3. Save Based on Goals. In your twenties and thirties, you probably saved based on ability: I can afford to save $300 a month, or, I’ll save 10% to my 401(k). That’s okay to start, but it’s not looking at what is actually needed to accomplish your goals. Maybe you didn’t even have a goal! When your goal is specific, a course of action becomes obvious. If your goal is to pay for four years of tuition at a certain university, we can project how much that will cost and how much we need to save to achieve that goal.

For financial independence, start with your living expenses and apply a 4% withdrawal rate. If you need $60,000 a year to spend, that would require a portfolio of $1,500,000 (4% = $60,000). Now you have a specific goal. How much do you need to save to get to $1.5 million at age 65? Can you do it by 62? Are your investments likely to achieve the return necessary to reach your finish line? Your actions – spending, saving, and investing – should be based on a plan for your goals.

See: Setting Your Financial Goals

4. Family Needs. Increasingly, we are seeing adults who besides having to plan for their own future and their children’s needs are having to help their retired parents with care or financial support. Have a conversation with your parents and understand how they have planned for their retirement. Do they have a retirement income plan and an estate plan? Are you seeing any signs of memory loss or a decline in cognitive skills? These are signs of potential difficulty managing money in the future. If your parents are in their seventies or older, it might be a good idea to have conversations about money and their wishes. And of course, they might need a financial planner to help them as well.

See: Financial Planning for the Sandwich Generation

5. Umbrella Policy. When it comes to insurance, don’t just get “a” policy. Take the time to understand what your policies cover and exclude and make sure your coverage is more than adequate. People who look only at getting the lowest rate on their home and auto insurance are likely to be disappointed by their coverage, exclusions, and deductibles if, or should I say when, they have a claim. It’s important to make sure you have enough insurance, especially as your net worth grows.

That’s why I recommend clients consider an Umbrella Policy, which will supplement the liability coverage on your home and auto policies. If you have a car accident, your umbrella policy can provide another $1 million or more in coverage above the $250,000 limit on your auto policy. For a few hundred dollars a year, it’s worth owning an umbrella. If you don’t have a policy, or want to shop rates, I can refer you to an independent agent who can help you consider your options.

See: Don’t Forget Your Umbrella

Financial Planning In Your Thirties

In your thirties, you are establishing the financial habits which will last for the rest of your life. Choose carefully! You might think that it was tough to save and invest in your twenties. Well, I wish I could say things get easier in your thirties, but there are going to be new demands and expenses. You might still have student loans, but will be adding in a mortgage and car payments. Besides your own expenses, you may have a young family and all the joys and bills of day care, pre-school, and then clubs, sports, and music lessons. Your time and your money can disappear very quickly!

It’s important that you don’t delay your financial planning for another year. One year can turn into five or ten before you know it. I know it is easy to feel overwhelmed with all the financial pressures you face. Although there is a lot to do, we can help you get through the process and take the steps to create financial security and eventually, financial independence.

1. Catch Up. Most people in their thirties still need to do some of the key steps we discussed for your twenties: establishing an emergency fund, managing debt, tracking net worth, starting investing, and getting term life insurance.

See: Financial Planning in Your Twenties

2. Increase Savings. As your career progresses, you may find you are being promoted from entry-level to higher paid positions. You might change employers, relocate, or even pursue a new, more lucrative career. From 30 to 39, you might see a significant increase in your income. The question is: When you get a raise, will you spend it or save it? If you can get in the habit of increasing your saving and investing, you can generate a significant amount of investment capital in your thirties.

The challenge is that you will see so many friends who are buying a bigger house, leasing two luxury cars, taking lavish vacations, or buying a boat or a lake house. You have to resist the temptation to “Keep up with the Joneses”. They may be taking on a vast amount of debt to fund their lifestyle and are not being responsible with their money. Just because a bank will give you a credit card or loan, doesn’t mean it’s a good idea to spend the money.

3. Put Your Investing on Auto-Pilot. What works is squirreling away money consistently. Set up the accounts you need: 401(k), Roth IRA, 529 Plan, Health Savings Account (HSA), etc. Pay yourself first and set up monthly automatic contributions to each account. Don’t worry if you have to start small, you can always increase your amounts later. If you don’t make contributions automatic, you probably aren’t going to have an extra $5,500 lying around at the end of the year to fund your IRA.

See: How Much Should You Contribute to Your 401(k)?

4. 15-Year Mortgage. If you begin your house search process with the pre-approval for a 15-year mortgage, you can save a fortune in interest over the life of the loan. Of course, you also have the opportunity to own your house free and clear in just 15 years. Even if you move after 10 years, you will have significantly more equity if you started with a 15 year rather than a 30 year loan.

See: The 15-Year Mortgage: Myth and Reality

5. Start a 529 College Savings Plan. The sooner you can starting saving for your kids’ college, the more time you can enjoy the benefits of compounding. And since a chief benefit of 529 Plans is tax-free growth, you get more benefit by starting at age 6 than at age 16. An early start is helpful.

See: How Much Will It Cost to Send Your Kids to College?

6.  Establish an Estate Plan. No one wants to think about their own mortality, but this is an important step that you need to take. If you have minor children, you really do not want to leave decisions about what happens to your children (and the money to support them) in the hands of a Judge who doesn’t know you. Courts are bound by rules that may lead to outcomes that you would not have wanted. I can refer you to an attorney who can complete this process with you. The cost for most plans will be only $750.

See: What Happens If You Die Without a Will.

Financial Planning in Your Twenties

In your twenties, you are out of college, starting your career and maybe will be starting a family soon. What is most essential is to realize is that financial planning is not just for people your parents’ age who are getting ready to retire. Financial Planning is for YOU!

The steps you take in your twenties will lay the groundwork for the rest of your life. Will you become wealthy or will you be just one step ahead of your bills and debt like many Americans? A lot of us older folks wish we could be twenty-five again but with what we know at 45 or 65. Then we could get an early start and be in much better position later.

So, let’s get organized, educate ourselves about money, investing, and taxes. Define your goals and create a written financial plan. It’s an exciting time to be seeing your hard work starting to pay off. There are plenty of money issues that create a lot of stress: student loans, credit cards, buying a car, housing affordability, low paying entry level jobs, etc. We need to tackle those issues head-on.

Here are five crucial steps for being in your twenties.

1. Emergency Fund. Keep three to six months of living expenses in a safe, liquid account that is separate from your regular checking or bank account. Unplanned expenses are an inevitable reality of life. Cars break down, houses need repair, injury or illness happens. It’s not really a matter of “if” these things will occur, but just when. An emergency fund is a prerequisite before you can start to invest for long-term goals.

2. Manage Debt. Avoid taking on new debt and be smart about managing your existing liabilities, such as student loans, car payments, and credit cards. You have to plan for how to pay off your loans, while still having a plan for the rest of your financial goals, too.

See Should You Invest or Pay Off Student Loans First?

3. Annual Net Worth Statement. Adding up all your assets and liabilities is a key step to managing your financial life. Understand where you are today and direct your cash flow to grow your net worth. By tracking this annually, you are not only measuring your progress, but creating a sense of urgency that will help align your short-term decisions with your long-term goals and dreams.

4. Start Investing NOW. Don’t think that you can make up for lost time later. Compounding works over time and the earlier you start, the earlier you can reach the finish line.

See The Cost of Waiting from 25 to 35

5.  Term Life Insurance. You might not have significant assets today, but when you are young, you have the largest amount of future lifetime income. If you have a spouse or family, the greatest need for protection is at age 25, not at 65, when most of your earnings years are behind you. We don’t use insurance as an investment; it is to protect against potentially devastating and rare risks. So, buy a term life policy. If you are healthy, it may be only a few hundred dollars a year. And if something were to happen to you, the term policy would be the most important financial planning step we took. Don’t skip this!

See A Young Family’s Guide to Life Insurance