When Good Estate Planning Advice goes Horribly Wrong

 

I just got back from a funeral for my dear friend and buddy. He took my good financial planning advice over the years --- so why did he leave a horrible mess behind?

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A Sad Tale of Good Estate Planning Advice Gone Wrong

Why You NEED a Mortgage

You need a mortgage. Sounds crazy right? Isn’t sound financial planning and wealth building strategies all about saving and investing? Not necessarily. It is about saving and invest and keeping more of what you earn. That means keeping a careful eye on taxes. One of the biggest tax deductions (other than your retirement plans like a 401K) you can take is the mortgage interest deduction. When you take out a mortgage most of your payment is interest and all of that interest is deductable. If you have a mortgage, take a look at your Schedule A Itemized deductions federal tax form.  Under interest deductions, you will see how much you wrote off of the total amount of yearly mortgage payments. Why so much? Because almost all mortgages are fully amortized, this means that each payment is part interest and part principal.  In the early years you will see that almost all of your payments are interest. You can get a mortgage amortization schedule of your mortgage on an online calculator if you really want to get exact.

Most people focus on the payments that they make on their mortgage. There wealth building strategy is to get a lower payment. That can be a really bad strategy in some situations. Let’s look at two in particular:

1. John is getting ready to retire. His wealth building strategy is to pay off his mortgage so he has less debt. He will live on his social security, income from his 401K, and some part-time job income. What John doesn’t realize is that by paying off his mortgage, he may be paying more taxes than when he was working. Why? The income from his 401K and his part-time job is taxable. He doesn’t have any mortgage interest deductions to reduce that taxable income so his taxes are higher and part of his social security is taxed too. John is not happy about the choices he made.

1. Sue bought a house 15 years ago. She has just come into an inheritance. She wants to refinance and use her inheritance to pay off most of the mortgage. She figures she will be able to work part-time if she doesn’t have a big mortgage. Sue refinances at a lower rate and uses all of her inheritance to pay off most of the mortgage. Sue now finds that she can’t live on her part-time income even with a lower mortgage. Her taxes on the lesser income are much higher and her take home pay is a lot lower than she expected. She will have to go back to full time work. She is not happy about the choices she made.

In both examples, there was good intention to do the right thing but not a holistic approach to the problem. You need to carefully consider tax planning with your Financial Advisor or Wealth Coach in any wealth building strategy that you choose but in particular with a mortgage or a refinance.

 

The Worst Financial Advice in the World

As part of your wealth building strategy, you should have a third party give you feedback on your personal financial plan. That could be a friend, relative, or a paid financial professional.  There is no guarantee that the advice or suggestions that you receive will work out and you need to use your own common sense and analysis to figure out the right thing to do. Unfortunately all humans are unique and we all come with different tax brackets, risk tolerance, and financial goals. That is why it is so difficult to commoditize financial advice. No matter how hard the brokerage industry tries to put your money into a portfolio box marked conservative, moderate or aggressive; you know deep down that certain aspects of your money does not fit in that box. So here are some common investment advice remarks that you should run from:

It will eventually come back to what you paid for it.  Don’t count on it. Every time you buy an investment you should have a plan for when to sell it. Just hoping that it will come back to what you paid for it isn’t going to make it happen. You must have a benchmark to consider whether the investment is worth sticking with. If your small-cap stock fund is going down and all small-cap stock funds are going down, why would you sell it? Realize that markets go up and go down and you must have a selling strategy as well as a buying strategy.

You are young so you can afford to take more risk.  I have seen young people who are risk adverse and elderly people that can stomach wild swings in the market. Where are you in the spectrum? Don’t let anyone judge what type of portfolio or risk tolerance you have by your age alone. Your risk tolerance should coincide with your financial goals not just your age.  

You are in a high tax bracket so you need to put every penny into tax deferred plans.  Yes, tax deferred plans like the IRA, 401k, 403b, etc. can help save on taxes but the end result can be a very high taxable income at retirement. The 3 pillars of income sources to replace a paycheck are Social Security, tax deferred plans and pensions, and investment accounts. By having these three, you can minimize taxes at retirement and net more income. If you are heavily withdrawing from tax deferred plans for paycheck replacement, you will find your Social Security being taxed and you may be in a higher tax bracket than when you were working.

You won't get any tax deduction from that investment.When considering an investment you need to first figure out if it is suitable for you which include taxation, but it should not be your sole consideration. A higher return on an investment may offset the taxes paid.

It won’t cost you a thing.  No commission and no-load does not mean free. There is a cost to everything and you need to find out what it is. Once you do, you can compare it to others and see if the fees are reasonable for what you get or extraordinary and will eat into any returns you get. Read the fine print and you will see in every investment that someone is getting paid.

I guarantee it. Guarantee is a dirty word in the investment world and you will rarely hear anyone say it. If you do, run don’t walk to the nearest exit. Nothing is guaranteed. You may find “teaser rates” that guarantee you a certain high return and then after the rate lock, drop like a rock. So carefully look at the full term of the investment and not just any attractive start rate.

Keep your wealth building strategy on track by avoiding investment advice like the above.  Have someone like a Wealth Coach review your personal financial plan once a year to make sure that you are on track to meet the financial goals that you set that have your risk tolerance and tax bracket factored in. Your ability to build wealth depends on it.

 
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