Challenge your existing financial beliefs for fun and profit.
Every financial action we take has economic reactions. The reaction can diminish or even steal away the result we hoped for, without our knowledge or consent. Knowing the reaction in advance can preserve wealth and prevent some major financial disappointment. We have chosen eight common financial actions that have that potential.
Click each toggle below to view the answers:
Mortgages
- Paying cash or making a large down payment on a home saves me money.
- A 15 year mortgage saves me money compared to a 30 year mortgage.
- Making extra payments on my mortgage saves me money over time.
All three questions have a related response:
- Home equity earns no interest. The money paid to avoid, eliminate or reduce a mortgage balance earns nothing.
- The amount of home equity has no effect on market value. Identical properties will sell for the same price whether it is paid for or is fully mortgaged.
- Accessing home equity, even for a fully paid for home, requires a willing lender. If the homeowner is disabled or unemployed, or deemed a poor risk, the equity can be unreachable regardless of the severity of need. Also, at the time of this writing major banks and discontinuing HELOC loans altogether.Certainly, paying off or paying down a mortgage will save mortgage interest. And, certainly, the money used to do so could be saved or invested instead to earn and compound growing personal wealth over time. Not earning that growth is Lost Opportunity Cost.The answer to which is better for one’s personal circumstances must include accounting for lost opportunity cost, tax deduction differences, and inflation. With our Mortgage Master software, we can provide help in reaching an accurate comparison.
Retirement
- Participating in a 401k, IRA, or other government plan saves me taxes.
- I will have a lower tax rate when I retire.
Do I save income tax by participating in a government plan?
(IRA, 401k, SEP, TSA, Thrift and similar plans.)
This question must be broken down between “now” and “later”. First, do I save income tax now? Does participation in a government plan increase my spendable money supply or available cash flow now?
No. The tax you would have paid now on the contribution amount goes into the plan, where it remains the government’s money, to be paid later. There is no escaping it: you either pay it now and keep the rest or you pay it later out of the plan and keep the rest. If you put $5,000 in today you cannot take $5,000 out tomorrow. The unpaid tax that was put in the plan will be paid when the money is taken out, along with their share of the growth on their share of the money, whenever that is.
For another perspective, we will look at Person A and Person B. They are “clones” except for one thing: one participates in a government plan and one does not.
| Person A | Person B | |
| 100,000 | Gross Income | 100,000 |
| 10,000 | Contribution | 0 |
| 30,000 | Itemized Deductions | 30,000 |
| 60,000 | Taxable Income | 70,000 |
| 16,800 | Tax @ 28% | 19,600 |
| 43,200 | To Spend on Lifestyle | 43,200 |
| 0 | Net Left to Invest Elsewhere . |
7,200 |
| 100,000 | Total | 100,000 |
| 0 | Advantage | 0 |
Another view: What you would have paid in taxes today is put into the plan to be paid later.
$10,000 Contribution:
| Government Plan $ 2,800 Their Money (Tax Dollars) $ 7,200 Your Money $10,000 Total |
| $10,000 Withdrawal:
$10,000 Total |
There is no current benefit, no increase in spendable cash, created by participating in a government plan. Other than a 401k loan, money cannot be removed at any time or in any way without the payment of the appropriate tax. In addition, there are substantial penalties if the money is withdrawn outside the government mandated rules. The tax amount was never yours and never will be yours. It is their property, earning interest for them, inside the plan, and is given to them when money is taken out of the plan.
If a 401k is taken it must be repaid within 5 years to avoid penalty. The loan is repaid with after tax dollars which creates multiple taxation because it will be taxed again when taken out later.
Will I save taxes later? Is there a future benefit? Will I have a lower tax rate when I retire and take the money? Here are a few factors to consider:
The total of all income received, including all government plan income, determines your tax rate.
For most, tax deductions will be minimized or gone by then, increasing the likelihood of being in a higher tax bracket during retirement.
Government plan income may cause Social Security income to be taxed.
There are no guarantees that money will not be needed or wanted before retirement. This will create state and federal income taxes, up to the maximum rate depending on the amount taken, plus state and federal penalties.
There are no guarantees that life events will not cause lump sum withdrawals after retirement. On top of any and all other income sources, this will be taxed up to the maximum rate depending on the amount. (Consider health factors and unexpected needs or wants.)
One may not live long enough to “draw down” their account enough to avoid the maximum tax hit when the balance is paid out to heirs. State and federal taxes can easily consume 40% to 50% of the account balance.
Personal wants and needs, and inflation, along with the lack of deductions, may require withdrawals of an amount that create a tax rate higher than the tax rate at the time the money was earned.
There are many factors, including real life events beyond our control, that can cause maximum taxation rather than reduced taxation. There is also the possibility of higher future tax rates, something many consider likely due to the ever-growing national debt.
We must also account for the “Macro” effect of plan participation.
We are consumers over our entire lives. Never ending, it only changes form. To fill the demands of our wants and needs we need cash. Without enough cash, we must use credit. Then, the interest on debt significantly increases the cost of everything we buy.
With money locked up in a government plan by tax and penalty, the amount of debt is increased. The cost of that debt offsets what we may earn in the plan. With many, it is actually greater.
As we have shown, there are no current tax savings by participating. Then, debt costs offset or exceed what we may earn in the plan.
We suggest that the government plan decision involves economic issues far beyond what is explained by those that promote the plans and enroll people in them. For you own well-being we urge careful consideration of the factors involved.
Financing
- Paying cash saves me interest costs.
We finance everything we buy. We pay interest to banks or lose Interest (growth) forever on the cash that is paid.
Let’s say you pay $25,000 cash for a car.
If kept, let’s say the cash could have earned a net 4% interest. In 30 years, at retirement time or during retirement years, it would have grown to $108,048. You have suffered lost growth, Lost Opportunity Cost, of $83,048.
That is for one car. Consider the total of the Lost Opportunity Costs on the big-ticket items we regularly pay for such as furniture, vacations, home maintenance and improvement, health costs, just to name a few.
We can show you how to “be your own banker”, to recoup the interest that would be paid to banks or lost to paying cash, keep it working for you, and have about 80% of those Lost Opportunity Costs in your own account.
Protection:
- I can spend the death benefit of my life insurance, while living, to enjoy a better retirement.
- Long Term Care insurance is the best way to protect against long term care costs.
We finance everything we buy. We pay interest to banks or lose Interest (growth) forever on the cash that is paid.
Let’s say you pay $25,000 cash for a car.
If kept, let’s say the cash could have earned a net 4% interest. In 30 years, at retirement time or during retirement years, it would have grown to $108,048. You have suffered lost growth, Lost Opportunity Cost, of $83,048.
That is for one car. Consider the total of the Lost Opportunity Costs on the big-ticket items we regularly pay for such as furniture, vacations, home maintenance and improvement, health costs, just to name a few.
We can show you how to “be your own banker”, to recoup the interest that would be paid to banks or lost to paying cash, keep it working for you, and have about 80% of those Lost Opportunity Costs in your own account.
If there is life insurance in place, the cost of Long Term Care may be “leveraged” against existing assets with the ultimately paid death benefit reimbursing the costs. We can show you how.
Please contact us if you would like to explore this further.