5 Great Questions to Ask Yourself
By Kevin Estes
Five great financial questions to ask Yourself
The following questions keep coming up in financial planning conversations:
What do I want my money to accomplish?
How do I minimize lifetime taxes?
What if I’m injured?
How can education costs be reasonable?
Are my assets in the right location?
1) What do I want my money to accomplish?
If you don’t know where you’re going,
any road will get you there.
Starting with the end in mind can be powerful.
A clear goal can simplify thousands of decisions. It also helps someone track progress toward their vision!
Below are some popular goals.
Pay off debt
The order of debt repayment is often:
consumer debt (credit cards),
student loans, and
home mortgage.
It’s functional yet uninspired. It might also not be the best use of someone’s limited cash flow!
Start a family
Major life changes are a paradox:
If you wait for the right time,
you’ll never do it.
That goes for getting married, moving in together, having or adopting children, etc. Each will feel like a stretch regardless of preparation!
People take leaps when conditions are alright - not ideal. It’s a growth opportunity.
Change careers or start a business
Similar to starting a family, there’s rarely a good time to switch careers or launch a company.
Big professional moves often require:
a time investment,
an increase in expenses,
a reduction in income,
or all of the above.
It’s important to have a long financial runway before heading off in a new direction.
Pay for education
Quality education is both important and subjective. A good education for one person could be terrible for someone else!
How you go
matters more than
where you go.
Some potential ways to reduce education expenses are discussed below.
Reach financial independence
The word retirement conjures up images of:
quilting,
shuffleboard, and
Bingo!
Financial independence is the ability to do what, when, and with whom you like.
Someone reaches financial independence when their lifestyle no longer depends on their earned income. If they work, it’s because they want to - not because they must.
Even within the financial independence community “next endeavor” gets a better reaction than “retirement.” The reason is likely because “retirement” - especially “early retirement” - sounds fundamentally anti-social. Early retirement could stop some of the most educated, resourced, and driven people from helping others!
However, that’s not usually how it plays out. People who reach financial independence:
take care of sick parents,
help out with their grandchildren,
volunteer,
organize local events,
change careers,
launch businesses, etc.
Travel internationally and enjoy vacations
Life begins and ends with limited mobility. Exploration peaks somewhere in-between.
Vacations and international travel could impact other life decisions.
Consider the following:
A ranch owner may struggle to travel. Livestock requires constant care and attention.
Someone who accepts an international assignment might use their new city as a home base to explore an entire continent.
Slow travel can be an especially economical way to explore the world. Multi-week rentals generally cost less nightly than hotel stays. Extended trips also make the most of expensive international flights.
Give to family and friends
Once people have covered their needs and enjoyed many experiences, they often consider giving to those close to them.
Charity begins at home.
At some point, spending becomes more about who than what.
Paying for someone’s medical or education expenses can avoid gift and estate taxes. Also, a limited amount can be given to an individual without incurring gift taxes. The thresholds for 20203 are:
$17,000 per person
$34,000 per married couple
Donate to causes
Beyond family and friends, people support causes which resonate with them. They could make nonprofit, political, religious, or other contributions.
2) How do I minimize lifetime taxes?
Everyone’s tax situation is different. Nonetheless, taxes could be someone’s biggest lifetime expense!
Taxes include:
income,
property,
sales, and
other taxes.
It’s worth considering how to minimize these expenses.
Income tax is usually someone’s largest annual tax expense. It’s also progressive:
The more you make,
the more they take.
Income tax rates rise with taxable income. According to the IRS, the 2023 federal tax rates for married individuals filing jointly are:
10% for $0 to $22,000 of taxable income,
12% for $22,001 to $89,450,
22% for $89,451 to $190,750,
24% for $190,751 to $364,200,
32% for $364,201 to $462,500,
35% for $462,501 to $693,750, and
37% for $693,751 and above.
Keep in mind that these tax rates are on income above the standard deduction. That deduction is $27,700 for married individuals filing jointly in 2023.
Fortunately, there are ways to reduce lifetime taxes!
Contribute to Health Savings Accounts
Health Savings Account contributions are triple tax advantaged since they:
reduce taxable income for the year they’re made,
grow tax-free, and
can be withdrawn tax-free for qualified medical expenses.
They even avoid Social Security, Medicare, and federal unemployment tax!
The biggest downside is that contributing to a Health Savings Account requires someone to be on a High Deductible Health Plan (HDHP). It’s important not to let the tax tail wag the healthcare dog.
Contribute to employer retirement accounts
Another way to reduce lifetime income is to move income from higher to lower income years. That’s one of the biggest benefits of contributing to workplace retirement accounts like a 401(k), 403(b), and 457(b). They’re named after their location in the federal tax code.
Employee contributions:
reduce taxable income for the year they’re made,
grow tax free, and
are taxed when withdrawn.
Unlike Health Savings Accounts (HSAs), they’re not triple tax advantaged. However, they might move income from a higher tax rate to a lower one. The money that would have been taxed initially also gets the opportunity to grow tax-free.
Also unlike HSAs, retirement plan contributions don’t avoid payroll taxes like Social Security, Medicare, and federal unemployment taxes.
Contribute to an Individual Retirement Arrangement (IRA)
Millions of workers don’t have access to an employer retirement plan. They might instead contribute to an income-reducing Individual Retirement Arrangement (IRA).
For instance, a spouse without earned income may be able to fund to their own IRA. Contributing could lower their married filing jointly income while saving for the participant’s future.
As with employer retirement plan contributions, funding an IRA could delay income from a time of higher income to one of lower income. The hope would be to lower the effective tax rate on that income.
Contribute or convert to a Roth IRA
It might make sense to fund a Roth Individual Retirement Arrangement (IRA) in a year with relatively light income.
Roth IRA contributions:
are taxed in the year they’re made,
grow tax-free, and
can be withdrawn tax-free if certain conditions are met.
It might even make sense to convert some funds from an employer retirement account or traditional IRA to a Roth IRA. Doing so deliberately increases taxable income in a low-income year.
Such income may incur very little tax because of the deductions (especially the standard deduction) and low tax rates. It may make sense to pay taxes now instead of at a higher rate later!
A Roth conversion may be especially helpful for people who were impacted by a layoff, started a business, or both.
Maximize deductions for charitable donations
The Tax Cuts and Jobs Act reduced how many people itemize their expenses. That reduced how many people receive tax benefits from nonprofit contributions.
Nonetheless, strategies can help maximize charitable tax deductions such as:
donating appreciated securities,
bunching donations into one year, and
establishing donor-advised funds (DAFs).
3) What if I’m injured?
It’s easy to consider cutting corners on insurance. After all, insurance companies are for profit! On average, premiums must exceed payouts.
Unfortunately, serious injury or even death can strike at any time.
Life insurance
From a financial perspective, death is the easier use case.
After someone dies, everything stops:
their earned income falls to zero and
they can no longer do what they were doing for their family.
A family with children may receive some Social Security benefits - usually until the youngest child turns 18. Widows/widowers with older children can begin receiving survivors’ benefits at age 60.
That leaves years without any benefits.
Take the following example: a 24 year-old with a newborn baby tragically loses her husband.
She and the typically abled baby would receive benefits for approximately 18 years until she’s 42 years old. Once the child graduates high school, all benefits stop. As long as the widow doesn’t remarry, she’d again be eligible for survivors’ benefits at age 60.
That might leave 18 years - age 42 to 60 - with no benefits!
Disability Insurance
Financially, disability is similar to death - except costs typically rise. Medical and other costs increase at the same time income falls.
The Social Security definition of disability is extremely limited. With some exceptions, someone usually only qualifies for Social Security disability insurance benefits if they’re unable to work any job.
Consider a surgeon who can no longer operate yet can still greet retail customers!
It’s important to consider what the family’s financial needs might be including things like additional childcare, care for the injured adult, and help around the house.
Having appropriate insurance might avoid financial disaster.
4) How can education costs be reasonable?
Education costs, especially college, can be expensive.
Cost of attendance
According to the National Center for Education Statistics, the cost varies significantly. Below is the average cost of attendance (tuition and fees) of a degree-granting institution for a first-time, full-time undergraduate student in 2021-22.
Two-year institution:
Public $3,970
Private nonprofit $17,735
Four-year institution:
Public $9,678
Private nonprofit $38,768
Attending a two-year public institution and then attending a four-year institution might cost $27,296:
Year 1: $3,970
Year 2: $3,970
Year 3: $9,678
Year 4: $9,678
That’s only about 70% of the tuition cost of a private nonprofit for a single year!
Attending a private nonprofit for four years might cost roughly $155,072. That’s nearly 6x the cost of the public 2-year to 4-year path.
Benefit of education
More educated people tend to earn more. Tapping another National Center for Education Statistics study, the median annual earnings of full-time, year-round workers ages 25-34 in 2021 was:
$32,500 for less than high school completion,
$39,700 for high school completion,
$41,000 for some college, no degree,
$45,000 for Associate’s (two year) degree,
$61,600 for Bachelor’s (four year) degree, and
$74,600 for Master’s or higher degree.
For many professions, how the student performs in their studies matters more than where they attend. If the student is planning to attend graduate school, grades and graduate admission test scores likely matter more than the prestige of their undergraduate institution.
What a graduating student studied - their major - often has more of an impact on their earnings than the prestige of the university they attended.
risk
However, there’s more risk starting out at a 2-year public program. A student who performs poorly at a public 2-year program may not be accepted to a public 4-year program.
Colleges with higher prestige - on average - offer more career opportunities than less prestigious institutions. There’s also value in the social networks students build at nationally ranked universities.
Every situation is unique
It’s important to not only consider a school’s published tuition and fees but also what students actually pay. The difference may be significant, especially due to:
financial and
merit aid.
Financial aid
To become even more selective, many top universities now cover substantially all of the cost of attendance for low-income families.
According to Harvard’s financial aid office:
24% of Harvard families pay nothing and
55% receive Harvard scholarship aid.
It may be less expensive for the student of a lower-income family to attend an Ivy League college than an in-state public university!
Many colleges now have a Net Price Calculator (NPC) on their website. These calculators give families a sense of how much it would cost for their student to attend before applying.
It’s important to fill out this information correctly and save the results. The results might be used to appeal a financial aid award if it’s substantially different than the NPC estimate!
Merit aid
While the most prestigious colleges may meet 100% of financial need, they don’t typically offer merit-based aid.
Merit aid includes scholarships and grants for exceptional students. They’re primarily based on:
high school or Associate degree Grade Point Average (GPA),
courses taken, and
standardized test scores.
The definition of “exceptional” is relative. An average student for one college might be exceptional for another.
This is a good reason to apply to a variety of schools - including “safety” schools. It’s possible a good school may offer so much merit-based aid that it becomes the best overall value.
It’s also possible to negotiate between schools. If a student prefers a school with a higher all-in cost of attendance than another, it may make sense to give the higher preference school an opportunity to match the offer!
Beware: merit aid may require students to maintain good grades. It’s not uncommon for a school to require a 3.5 GPA for merit scholarships knowing the college’s average GPA is a 3.0. Students who lose their merit-based aid due to lower grades may have few transfer options.
5) Are my assets in the right location?
Many people consider investment allocation. An asset allocation plan helps someone determine how to invest their overall portfolio based on factors like their:
risk capacity,
risk tolerance,
investment timeline, and
goals.
However, asset location is also important. Account types have different characteristics which may determine where assets are held.
Emergency Fund
Money in an emergency fund need to be readily accessible at the fair market value.
The problem with stocks and even bonds is that although they can be sold quickly, the markets can move even faster.
It’s important for emergency funds to be quite conservative. Potential investments include things like:
High-yield savings accounts and
Money market accounts.
The best investment will depend on the situation.
Taxable Brokerage Accounts
These accounts generate taxable income for the current tax year. However, these investments can usually be accessed penalty-free.
A taxable account is often a good place for individual stock shares. Such investments may be tax-deferred until they’re sold.
Dividends increase taxable income. However, qualified dividends are generally taxed at a lower rate - often 15%.
Another good investment for these accounts is a low-cost, broadly diversified index or mutual fund. The tax treatment is similar to holding individual stocks. However, the volatility is generally lower and dividends may be higher. The index or mutual fund may also generate capital gains based on turnover of the underlying investments. Active management could result in sales throughout the year which impact short-term and long-term capital gain taxes.
Taxable accounts could also be the ideal location for municipal bonds. Owning them there could help someone take full advantage of the federal tax-free income.
However, it depends on the situation. If someone has limited income and must live on their investment income, it may make sense to hold high-yield dividend or bonds in taxable accounts.
Traditional Retirement Accounts
These are accounts like 401(k), 403(b), 457(b), and the traditional Individual Retirement Arrangement (IRA).
These accounts are mixed bag:
Good: they don’t generate income until funds are withdrawn
Bad: they generate income once withdrawn
Retirement accounts may an ideal location for non-municipal bonds and high-yield dividend stocks. Such investments tend to grow more slowly and produce more income than other investments. Retirement accounts offer an opportunity to defer taxes on that income - especially during peak earning years.
Roth IRAs and Health Savings Accounts
These accounts continue to grow tax-free until withdrawn. If the funds are used in a qualified way, they may even avoid tax once withdrawn:
Roth IRA - if they meet the 5-year and minimum age rules
Health Savings Account - if withdrawn for qualified medical expenses
It may make sense for these accounts to house some of the more aggressive investments in the portfolio. Over the course of years or even decades, the higher risk may produce a higher return. Growing these accounts accounts could avoid taxes altogether.
Having large balances might also:
reduce taxes for those who inherit a Roth IRA and
fund long-term care with an HSA should the need arise.
If you’re interested in getting your financial questions answered…
Disclaimer
In addition to the usual disclaimers, neither this post nor this image includes any financial, tax, or legal advice.
