The 3 Ways to Spend Your Tax Refund

Good morning, afternoon, or evening as the case may be! This months topic is tax related. What do you do with your tax refund?

First let’s talk about what a refund is just to set some perspective. Everyone I talk to gets so excited that they have a huge refund coming their way. Huge is relative by the way. Maybe the refund is $500, maybe it is $5,000, or maybe it is $10,000. The average refund is about $3,000. Many people receive this check in the mail and view it as free money fallen from heaven delivered from the mail gods. Let me just remind you that tax refunds are money the IRS is returning to you that you pre-paid, in excess, throughout the year. In other words, the federal government got to use your money throughout the year above and beyond what was due to them, and now they are giving it back to you. That is the mentality to look at your tax return with.

Now that we got that out of the way, what do we do with it? Here are some ideas:
1. Vacation – This is a very common option and I put it first because, let’s be real, this is the most fun. Tax refunds do go far towards a well-deserved vacation. Check out discount sites like Groupon and their air-inclusive travel deals. There are REAL discounts on flight/all-inclusive hotel packages. I personally want to book that trip to Paris and Spain for $799 in November.
2. Donate it – If you are anticipating higher income in 2017 vs. what you earned in 2016, consider donating it to a nonprofit organization for a tax write off when you file taxes in 2018. Plus it feels good to support worthy causes you care about. (insert shameless plug for Sierra Passport Rotary here)
3. Pay off high interest debt – Did you read the article in January? Please don’t pay down your mortgage with your tax refund… Do consider paying down high interest debt like maybe a credit card or a car loan. Start with the highest interest rate debt, not necessarily the smallest balance owed.

In closing, let’s talk about how to maximize your deduction next year. And by maximize, I of course mean minimize! Rather than setting yourself up to have a massive refund each year, consider working through (or hiring a tax professional) to calculate your right offs and adjust your withholdings on your W2 so that you have more cash flow all year long! My goal is to always have the smallest refund possible. I don’t know about you, but I like my money, and I like it working for me all year long rather than lending it to the federal government for free all year.

Exchange Traded Funds

I wanted to write about something year end related or maybe something related to the holidays. Then I met with not one, not two, but THREE clients who derogatorily said “yea, but they are ETFs…” when we discussed potential changes in their accounts. Therefore, this month is a crusade to educate on what an Exchange Traded Fund (referred to as an ETF) is. With that, how about we start with two big things you may not know about ETFs?

1. They aren’t just index funds anymore. I’ve heard people express that ETFs are just as overly diversified as mutual funds and can water down your returns as a result. Let’s start by saying, some of the first ETFs were products designed to mimic broad market indexes. However there are now hundreds of ETFs that range from index funds, to sector specific funds, to cross sections of indexes based on market capitalization, and with many other strategies and goals. Some even use custom indexes to benchmark against. Want to buy real estate, but can’t handle the liquidity issue it presents? There is an ETF for you. Want to buy into social responsible companies only? There is an ETF for you. This brings us to number 2.

2. The fees are lower than mutual funds because they are passive. Yes, mutual funds can be actively managed and ETFs still haven’t gained much traction in actively managed approaches. ETFs can be actively bought and sold by an adviser though and often the fee for hiring the adviser plus the fund fee is STILL less than the mutual fund. The reason ETFs have lower fees has nothing to do with management style and everything to do with how the products are created and offered. A mutual fund is a pool of money and you buy into that pool directly from the fund company. They have administration, operations, and other expenses they have to cover in addition to asset selection. An ETF is created by the fund creator and sold in a “Creation Unit” to an “Authorized Participant” which is a financial institution like a broker-dealer. Then the authorized participant can either keep those assets within the creation unit, or break up the unit into tens of thousands of shares in the ETF and sell it on exchanges to individual investors like you and I. This exchange of creation units between the ETF creator and the authorized participant makes the costs of creating shares in an ETF way lower than creating shares in a mutual fund and those savings are passed on to the investors in the form of lower expense ratios.

We went into a few more technical terms than I like to in this post. Hopefully I didn’t lose you and you learned something! ETFs can be used very effectively in a portfolio. They may not be of interest to you, but they can be very valuable to many investors from those just starting out to those well into retirement.

The 3 Financial Items on Your New Year To-Do List

Welcome to 2018! Hard to believe another year has already blown by. With a new year comes new opportunities, and I have compiled the three “C”s you may want to add to YOUR New Year’s to-do list:

1. Compile – The first financial move I like to make each New Year is compiling a summary of my finances. Things to include would be assets, debts, documents  (statements, estate docs, life insurance docs, etc), and a budget. This exercise serves multiple purposes. It is going to jog your memory on forgotten things from the year, like maybe that HSA account you made an opening deposit in and forgot about the last eight months. It is also going to help keep you organized for when you file your taxes or want to make sure you have gathered all tax related documents for your CPA.

2. Consolidate – In 2017 I had the privilege of meeting and working with many new people. I am always surprised by how many people come in with a 401k from their last job, 3 IRAs, and a SEP IRA for their consulting work that is easing them into retirement. Are you trying to make your life difficult? Who wants that many monthly statements and that many website logins? Why not roll over the 401k and consolidate the three IRAs into one account? The SEP IRA you may want to leave alone for now until you are done making contributions. Let’s simplify the next year for you! It will save you time, energy, space, and sometimes even money if your existing accounts have annual account fees or higher management fees on the separated lower balances.

3. Contribute – This was just the third word I thought of that started with the letter C. Let’s be honest, this article wouldn’t be complete without reminding you to check those contributions if you are saving for retirement. 2017 is gone and so is a year of potential for you to compound interest. If your employer offers a retirement plan with a match, consider taking advantage of or increasing contributions to get that match. It is free money. If you don’t have a retirement plan that offers a match, you need to evaluate if it makes more sense to save on a pre-tax or post-tax basis and consider setting up either automated contributions or at least reminders to make contributions to that account!

Ideal Account Characteristics

When you are thinking on and planning out your finances, it is really important to understand characteristics you favor before you fund financial vehicles. Many people take into account risk, rate of return, or time period.

When I look places to park money, these are the top account characteristics I look for, and can help you find:

Ideal Account Characteristics


Tax deferred growth means you aren’t paying tax while the money is just sitting there.

Tax free distributions means you don’t have to pay tax when you are withdrawing the money.

A competitive return is important to outpace inflation.

High contribution limits are an absolute must. Sometimes it isn’t enough to max fund a 401(k) that has a cap on it.

Deductible contributions could be advantageous.

Collateral opportunities are very important. This puts you in a position where you don’t need to withdraw money and interrupt compounding interest, but can still leverage your money.

A safe harbor with no loss provisions and guarantees are very important for people with low to moderate risk tolerances.

A guarantee loan option can be very important when capital is needed quickly. Think about trying to take a loan against the equity in your home and the long process that requires certain qualification. Having immediate guaranteed access can be a life saver.

In case the loan option is utilized, an unstructured loan eases cash flow pressure. Payments when you can make payments, paying any amount you like, not having the loan reported to crediting agencies. This is especially valuable to small business owners.

Liquidity, use, and control of the money. This is another absolute must. The ability to access, use, and maintain control of the money at any given time.

Any additional benefits you look for when you are comparing financial vehicles?

Who Even Needs an Annuity Anyway?

In ultra-conservative safe money you basically have four options:
1. A CD
2. The Cookie Jar
3. Cash
4. A Fixed/Indexed Annuity
Annuities are similar to CDs. They are for specified periods of time, there is a surrender or penalty charge if withdrawn early, and the higher rate you get, the higher the penalties will be if withdrawn early.
A CD is backed by the bank and the FDIC where an annuity is backed by the assets of the insurance company and the Life and Health Guarantee Association set up to help protect consumers.
When money is placed in a fixed/indexed annuity, the policyholder can elect to allocate money into a “fixed” bucket that pays a stated interest rate, usually with a guaranteed minimum. The policyholder can also elect to allocate money into various “indexed” buckets that vary by contract. These indexed buckets accrue interest based on the market index they follow with a stated cap. Let’s say your annuity is allocated to the S&P 500 index for a year period and your annuity’s cap is 8%. If the S&P 500 goes up 10% that year, your annuity will be credited 8%. Here comes the power of annuities: if the S&P 500 LOSES 10%, your annuity will avoid the losses. What does that look like? What if we went to a casino and I told you: “I will cover all of your losses, but you have to split your winnings with me”. Would you take my offer? That is basically what the insurance company is doing. They are pooling thousands of policyholder’s capital and offering to share earnings with you and cover all the downturns.
If you think the bank is in a stronger position than the insurance company, consider this: The only building as tall as the bank’s in a major city, is the insurance company’s building. between 2008 and 2012 only eight insurance companies went insolvent with a combined liability of $900 million. A fraction of the $639 billion in Lehman Brothers bankruptcy. And those policyholders with the insolvent insurance carriers received all their contractual benefits.
There are several important considerations when contemplating purchasing an annuity. The insurance company needs to make a buck. They are going to pay you a bonus as a policyholder, pay the adviser, they don’t charge a management fee, so therefor they need to hold on to at least a piece of the money for a period of time in their portfolios to turn a profit. Therefore surrender charges are in place to discourage too much withdrawing in early years.

There is a time commitment. Surrender charges are necessary because they allow the company to invest in the long term financial vehicles necessary to create this attractive indexed interest crediting method. Surrender charges can be avoided by the customer, because every fixed annuity allows for some portion of the annuity’s value to be withdrawn even during the surrender charge period without incurring the surrender charge.

So an annuity is a great vehicle for conservative safe money that doesn’t need to be touched in whole over a certain period of time. They are also great for individuals who feel it is more valuable to avoid financial losses than pick the winning investments. They can also be built as an IRA that is tax deferred!

The Effects of Inflation

In the world of retirement planning, inflation can be a deal breaker. Inflation is easily the number one most overlooked factor I see when talking about retirement planning with potential clients. In this calculation, I am going to show you the effect inflation can have an your retirement income!

For our example let’s use a 45 year old. We will assume this person graduated high school and entered the work force in 1987 for the purpose of calculating inflation.

Inflation 87 to 13





Now that we have established our average inflation rate, we will use this number to run our calculation. Now let’s assume our 45 year old is retiring at age 65, has a current income of $120,000 growing at 2.5% a year, currently has $80,000 saved, and is earning an after-tax rate of return on their money of 4.5%.

Inflation Calculation













This calculation is telling us in 20 years when our 45 year old retires, they are going to need to withdraw their current earned income of $120,000 plus an additional $89,977 from their nest egg to maintain the same lifestyle in retirement that they are while working! This 45 year old would need to be saving 94.08% of their annual income JUST to carry their current lifestyle into retirement! That obviously conflicts greatly and creates a war between current lifestyle and future lifestyle. When I put together creative financial strategies for clients I take inflation into account and create solutions that can hedge against inflation and other challenges that effect retirement income.

Have you answered the four toughest financial questions that relate to retirement? If not, when do you want to know:

  1. What rate of return do you have to earn on your savings and investment dollars to be able to retire at your current standard of living and have your money last through your life expectancy?
  2. How much do you need to save on a monthly or annual basis to be able to retire at your current standard of living and your money last till life expectancy?
  3. Doing what you are currently doing, how long will you have to work to be able to retire and live your current lifestyle till life expectancy?
  4. If you don’t do anything different than you are doing today, how much will you have to reduce your standard of living at retirement for your money to last to your life expectancy?