The next step in our journey to a financial plan is the estimation of any goals that require saving for, any college expenses that need to be accounted for, and how to better manage your taxes by estimating what it is you will owe. These three areas may not be a major concern for everyone but it is a group of things that always need to be considered. Compared to the first two steps this blog entry will be shorter as these areas are fairly straight forward with the exception of taxes.
If there are any special goals that you or your family have it is best to plan in advance for them and try to fund them over years and not at the end of your working years. Say you want to travel the country after you retire in a large fancy motorhome. Well as you may have guessed that is not an inexpensive purchase and will require either you save for the purchase or you will have to liquidate some of your existing assets to make the purchase. If you know that this is something you will want the more logical course of action is to save for the large outlay of cash by estimating what the cost will be in how ever many years away the purchase will be. As an example if you figure inflation will be 3.5% annually it will take more money to buy something in 20 years as it would be if you bought it today. That means the average cost of goods will increase at 3.5% a year every year over that 20 year period. This means that you need to have an after tax and after inflation adjusted returns that are at least greater than those two items combined. The reason taxes must be considered is most goals are funded in brokerage accounts and not in tax advantaged retirement accounts.
When saving for college there are some more options as compared to goals. One way to save for college is in fact the same way as a goal and that is in a taxable account that will have to produce returns that outpace not only taxes but the actual inflation factor of education which over the past few decades has been greater than that of general inflation. Meaning your account will actually have to return significantly more than the next option. And the next option is a state sponsored 529 college savings plan. These plans are tax advantaged and will grow tax deferred and the proceeds will be tax free if used on qualified education expenses. This is a huge advantage over a tax account as all the gains will continue to grow in these accounts and the return in theory will only have to keep pace with the inflation factor for education and taxes will not be an issue. In many states, they offer to reduce your state income taxes for any amount that you contribute to that state’s 529 plan so check your state to see what the tax advantages may be. But do shop around as different states offer different plans with different expenses associated with the investment options.
Taxes are more complicated and we will not go into them too much here. Taxes are also a touchy subject for many but this is one instance where everyone’s situation is different. If you are someone who gets a large tax refund every year you may be someone who needs to evaluate your tax withholdings. There is no need to give the government an interest free loan every year. In these instances adjust your deductions with your employer to withhold less in taxes. But on the other hand if you are someone who uses your tax refund as a savings account it may be worth it to you to continue to loan the government this money especially of you are a person who has trouble saving. The goal with taxes is to pay very little at the end of the year or to get very little back in the way of a refund. Use your prior year’s return as a guide to the current year and make your adjustments accordingly.