Improving Your Retirement
Improving Your Retirement
Top 10 Wealth-Management Pitfalls
By Sue Stevens, CFA, CFP, CPA | 08-30-07 | 06:00 AM
|You're smart. You're well-educated. You're doing well in life. Then why are you so worried about losing it all? Or worse yet,|
|maybe you aren't worried and you should be. |
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|Let's take a look at some of the biggest pitfalls on the road to wealth. If you're truly going to be successful, you'll need |
|to navigate carefully through the many hazards along the way. |
|1. Leaving Assets Unprotected |
|It's not going to do you much good to build up your wealth if you let it slip through your fingers. Any number of |
|catastrophes can occur along the way. Have you really protected yourself and your family? |
|Do you have adequate life insurance? If you died tomorrow, would your spouse or loved ones have money to pay some of their |
|biggest expenses like college or paying off the mortgage balance? Would they be able to stay in the same house and still be |
|able to pay the bills? Life insurance can help protect the assets you've built up by sheltering them from estate tax and |
|providing income replacement for your family. This is especially important when you have young children, a nonworking spouse,|
|or a big mortgage. You'll want to consider these needs as you weigh the cost of life insurance. |
|Another potential wealth destroyer is the dizzying cost of medical care in your later years. Have you considered long-term |
|care insurance? According to a study by the New England Journal of Medicine, 43% of people age 65 are expected to enter a |
|nursing home at least once before they die. Many people are in denial about long-term care. If you don't have a relative or |
|family friend who has gone through this process, you may not have given it much thought at all. For those of you who have |
|experienced it first-hand, you know the physical, mental, and financial strain that aging relatives can bring to the whole |
|family. Does everyone need long-term care? No. The very rich can self-insure, and the very poor won't be able to afford it. |
|For everyone else, it's worth taking a look at these policies. |
|Finally, consider how you are protecting your personal property. Is your home protected from fire, weather disasters, and |
|theft? How about acts of terrorism? Take a look at your homeowners insurance to be sure. You should also have adequate |
|coverage on your auto insurance. If you or someone in your family had an accident, would your insurance company pay for the |
|damage? What about lawsuits that could arise from an accident? Check to see what the underlying liability coverage is for |
|both homeowners and auto insurance. Protect yourself from property lawsuits by purchasing an "umbrella" policy. These |
|policies build on the underlying liability levels in your homeowners and auto policies and take your coverage up to the $1 |
|million range. The more wealth you've accumulated, the more umbrella coverage you should carry. |
|2. Mismanaging Cash Flow |
|The most successful wealth managers know that they must be disciplined in their spending. It's so easy to let expenses creep |
|up as you make more and more money. If you're not careful, those expenses can kill your chances of capitalizing on that |
|wealth. The first rule of any good financial plan is to pay yourself first. Make sure you are putting away a healthy portion |
|of your income and investing it. Don't live beyond your means. |
|Another aspect of managing cash flow is minimizing taxes. As your return gets more and more complex, you need to find |
|professional help to take advantage of every deduction you're entitled to. Your accountant can also help identify other |
|opportunities like additional retirement funding vehicles, mortgage refinancing strategies, and/or estate planning |
|techniques. At the very least, you should be discussing ways to use capital loss carryforwards (many of you will have these) |
|to your advantage. |
|During your working years, it is critical that you carry disability insurance. Many of you can purchase this coverage through|
|your employer. Take advantage of the opportunity to protect your income should something prevent you from working. It's far |
|more probable that you'll have a disability claim than a life insurance claim, and yet many people ignore this important |
|coverage. |
|3. Mismanaging Debt |
|A well-run company knows how to manage its debt. You need to think about debt management in your personal life, too. How much|
|debt is too much? Look at your shorter-term debts first--such as credit card debt, car loans, bank loans (other than |
|mortgages), and student loans. If your short-term loans add up to more than your liquid assets are worth, you probably have |
|too much short-term debt. (Liquid assets include cash accounts, brokerage accounts, and cash surrender value of life |
|insurance policies.) If you find yourself in this situation, you should (at the very least) examine the interest rates you |
|are paying on each loan and try to consolidate your debt at a lower interest rate. Home equity lines of credit work well in |
|many situations because not only are interest rates low, but the interest is tax deductible. |
|Mortgages can be a good way of managing debt because you get a tax break on the mortgage interest. But even with your |
|mortgage you should exercise some caution. Taking on more debt makes it harder to adjust should you find your circumstances |
|change (for instance, you lose your job). If at all possible, I'd try to keep mortgage debt below 75% of the value of the |
|property. Just paying your mortgage every two weeks throughout the year helps to cut overall interest payments over the life |
|of the loan. |
|4. Neglecting Your Finances |
|One of the biggest mistakes I see in wealth management is plain old lack of attention. People are very busy. Sometimes |
|personal finance takes a backseat to other more pressing matters. But if you take that approach, you may wind up feeling that|
|the years have flown by and you haven't made much progress. Successful wealth creation takes a commitment of time. |
|5. Choosing the Wrong Investment Strategy |
|I've written entire articles about the pitfalls of investing. Even if you're able to generate a considerable amount of |
|income, you have to know how to protect and preserve that capital. |
|One pitfall a lot of people have experienced in the past several years is misjudging your risk tolerance. When the market |
|just keeps going up, it's easy to think you can handle the risk. But after seeing what happened in |
|2000-02, many investors rethought how much risk (or loss) is acceptable to them. Even as the market sets new highs now, it's |
|important not to forget the risk involved. |
|Another common mistake is not rebalancing periodically. Many people refuse to sell if they've lost money on an investment. If|
|your mix of stocks, bonds, and cash (your asset allocation) makes you very uncomfortable, you need to think about taking some|
|losses and moving to an asset allocation that is in line with your ability to handle risk. |
|If you do realize losses, you can try to make the best of it by being tax-savvy. No one likes to lose money, but those losses|
|can be a benefit at tax time. You can use $3,000 a year to offset ordinary income. You can net out an unlimited amount of |
|capital gains and losses against each other. Any losses you can't use right away can be carried forward indefinitely. This is|
|just one of many techniques you can use to create a tax-efficient portfolio. |
|6. Mismanaging Windfalls |
|Sometimes life hands you a little something extra. Maybe it's stock options or an inheritance or some other |
|once-in-a-lifetime event. Now that you've got that money, what do you intend to do with it? |
|Many of you will benefit from professional advice in these types of situations. There are almost always tricky tax |
|implications. For stock options, you have to understand what type of tax you may trigger upon exercise or sale of your |
|shares: ordinary income tax, capital gains tax, alternative minimum tax, or all of the above. Careful planning can help you |
|keep more of your windfall. |
|Over the next 10 years, $10 trillion will pass from generation to generation. Most heirs have no idea how to integrate that |
|wealth into their own portfolios. For more on that topic, read "Six Steps for Investing an Inheritance." |
|7. Failing to Maximize Retirement Plan Benefits |
|Sadly, the majority of participants in company retirement plans don't put away anything close to the maximum contribution. |
|For 2007, you can contribute $15,500 ($20,500 if you are over age 50 and your plan allows it) to 401(k) plans, 403(b) plans, |
|and 457 plans. If you have a profit-sharing or SEP plan, you may be able to sock away as much as $44,000 a year. |
|If you are at the executive level of your business, in addition to the "qualified" types of plans discussed above, you may be|
|able to take advantage of "nonqualified" plans. These plans allow you to put away money and defer paying tax on the income |
|until a future date when you take withdrawals. These plans have fewer restrictions on how much and who can contribute than |
|qualified plans do. The downside is that you cannot roll over these plans (in general) to an IRA. When you take |
|distributions, they are immediately taxable. In addition, if your company goes bankrupt, your nonqualified assets are not |
|protected. You'll stand in line with other creditors. Good planning can help you make the most of these opportunities. |
|Another potential retirement pitfall is making a mistake when rolling over your company retirement plan to a traditional IRA.|
|It's important to understand the tax issues, cash flow considerations, and potential penalties. For more, read "Tips for |
|Managing Rollover and Inherited IRAs." To better understand the "dos" and "don'ts" of pension planning, read "Set for Life |
|Through Your Pension Plan?" |
|8. Drawing Down Assets in Retirement |
|One of the biggest fears retirees have right now is running out of money too soon. You need to spend time thinking carefully |
|about what you'll have coming in during your retirement years as well as how much you expect to spend. You should probably |
|seek professional help to quantify the probability of whether your assets will provide the type of retirement you've |
|envisioned. For more ideas on drawing down assets in retirement, read "How to Tap Your Assets in Retirement." |
|Even with careful retirement planning, there's always going to be change. You'll need to revise your plan as time goes by. A |
|healthy dose of common sense also goes a long way. In times when the economy is sluggish and the stock market is gloomy, you |
|can at least control your own expenses. This can mean voluntarily tightening your belt by spending less as well as by |
|choosing investments with low costs. |
|Once you reach age 70 1/2, you'll have to start taking withdrawals from traditional IRAs and most company plans. For more on |
|how to calculate what to withdraw, read "How to Manage Retirement Portfolio Distributions." If you need a little help on |
|structuring a portfolio in retirement, read "Model Portfolios for Retirees." |
|9. Failing to Plan Your Estate |
|The estate-planning arena is loaded with wealth-management pitfalls. Many of you may not have any plan in place at all. |
|That's your biggest pitfall. The best way to care for your family if something happens to you is to put an estate plan in |
|place. To find out more about what a surviving spouse will need to do, read "Prepare Your Spouse for Financial Independence" |
|and "Financial Steps to Take When Someone Dies." |
|Other potential pitfalls include setting up a plan but forgetting to fund your trusts, and forgetting to change your |
|beneficiary designations on life insurance, company benefits, IRAs, and other accounts. Another important part of your |
|planning should include considerations for disability as well as death. Powers of attorney for health care and property can |
|help if you are disabled. So can living trusts. For more on estate- and gift-tax issues, read "Top 10 Estate-Planning |
|Mistakes." |
|10. Leaving Heirs Unprepared |
|One of the biggest concerns for families with significant wealth is how to teach their heirs how to responsibly manage the |
|money they'll eventually inherit. You can set up children's trusts within your estate documents that stagger the ages for |
|access to the money over time. For example, instead of giving the children all of their inheritance at age 25, when they may |
|not be emotionally ready for it, you can give them part of it at age 25, another portion when they are 35, etc. If they |
|"blow" the first installment, there is still a chance they can make the most of the remainder of the estate. |
|Having family meetings during your lifetime can also go a long way toward educating your loved ones on how to manage that |
|wealth. It can also head off potential family squabbles over what your intentions are with respect to your assets. |
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