The Power of Tax Deferral – November 2011

Important Deadlines

December 31, 2011

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Many Ways to Skin the “Tax Savings” Cat – The Power of Tax-Deferral
Kevin Shaw, CPA, PFS, CEO

As a tax planner, I start getting an increased volume of calls as the year starts winding down. “How can I save income taxes?” is the cry. Generally, I then sit down with clients and we identify areas in which additional tax deductions can be implemented. Deductions such as retirement plan contributions, HSA contributions, equipment purchases (for the self-employed) are a few examples of areas we can increase deductions and save taxes. Depending on the client’s marginal tax bracket, these deductions will generally save between 20% and 40% for the majority of my clients. This can add up to a decent reduction of the income tax burden.

However, there is an equally, if not more powerful, tool that can save significant tax dollars and is underutilized by many people. This tool is called tax-deferral. What does this mean? Effectively, it means that your investments grow over time without paying any taxes on the earnings (interest, dividends, capital gains).

Assume that over 30 years you invest $200 per month into two different investments; one with tax deferral (say an IRA) and one that pays taxes on its earnings. The funds are invested into the exact same mutual fund earning an average of 8% over the life of the investment. In the non-tax deferral investment, thanks to compounding interest, your investment will grow to $195,000 in 30 years. However, the same $200 per month investment over 30 years will grow to $378,000 due to the powerful combination of compounding interest and tax-deferral. The additional $183,000 in growth is all related to tax-deferral.

Gray = Taxable account

Red = Tax-qualified plan

Chart provided by www.valic.com

This is for illustration purposes only and is not a guarantee of future results

Does this mean that you should invest all of your money in tax-deferred investments? Of course not, your investment strategies have to cover a wide-range of personal goals and timelines. Most investment portfolios need a combination of liquid investments in non-tax deferred vehicles and long-term growth investments in tax-deferred vehicles. However, it is important to understand and utilize the power of tax-deferral. With proper tax and financial planning, you can save on short-term tax deductions now while earning even more money in the future with long-term tax-deferred investments.

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5 Questions to Ask Your Financial Advisor
Dave Palm, Financial Advisor

When it comes to your finances everyone wants to get the right advice and the best possible outcome. Choosing who you work with is sometimes a very daunting task. Whether you are sitting down with your current advisor or preparing to meet with a new one, we have developed some helpful questions to ask.

1) What type of advisor are you? Investment Advisor, Insurance Agent or a Financial Planner

Do the services offered by your advisor match your needs? Individual investment advisors might be able to give some very good advice about which investments to choose. Insurance agents can make recommendations on various insurance products and sometimes offer investment options such as fixed annuities. A financial planner can assist you with a broader range of financial questions. Keep in mind, a financial planner may also be an investment advisor and/or an insurance agent but the reverse isn’t always true. It is important to understand what licenses the advisor holds and what products they can offer you.

2) What is your philosophy toward Financial Planning or Investment Advising?

You will want to find out if the advisor’s style, values and methodology match up with your personal goals. Each advisor will have their own fundamental style and process on how they base their recommendations. It is important for this to be the right fit for both the client and the advisor.

For example, at Shaw & Associates, we believe as an investor you need both an “Offensive” and “Defensive” strategy. You need to have a strategy to grow when times are going well but you also need to have a strategy for when the economy is struggling. This philosophy may differ from other advisors. It is important to find an advisor with an investment philosophy that you identify with.

3) How many companies or product lines do you offer?

Some advisors work directly for a specific company and are limited to the products offered by that company. In contrast, an independent advisor may be able to offer multiple different options from multiple different companies.

Advisors tied to a specific company may offer very good options, but are they the most competitive options? The research responsibility falls on you. An independent advisor isn’t tied to one company or product line. They can shop the market on behalf of the client and make the necessary recommendations.

4) How do you get paid?

There are several different ways an advisor or planner may receive compensation.

• Fees – Advisors can receive hourly fees, flat fees, a percentage of assets managed, or a percentage of the annual investment income. Fees can be paid out of pocket or directly through the investment.
• Commissions – Commissions are usually paid by a third-party for placing investments with their company. Commissions are typically a percentage of the amount you invest in the product.
• Fees & Commission – Some advisors receive a combination of both fees and commissions. They may charge a fee to construct an investment plan but receive commission by actually placing the investment with a third party company.

While all of these forms of compensation are appropriate, it is important to understand which payment structure works best for your individual investment portfolio.

5) Where is my money being held?

Most investments are held with reputable third-party custodians. Your advisor or planner can still manage your accounts but the custodian actually holds the money and completes the trades. You will most likely submit investment payments directly to the third-party custodian. If you are ever asked to make a check out to an individual or your Advisor’s company your warning lights should be blinking.

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Marcie Hutchinson Celebrates 5 Years at Shaw & Associates

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