Your Financial Plan Is Your Future

Your Financial Plan Is Your Future

Photo credit to Malte Kramer

Betty Scott arrived at my office cradling a large display of yellow tulips with thick green stems. They were a glorious deep yellow, like ripe lemons dangling from a tree on a sun-splayed day.

“I knew you’d appreciate these,” she said with a wicked grin and an impish wink, referring to the harassment I had experienced in a Philadelphia investment office so long ago because of my desire to have yellow tulips on my desk.

“You know what,” she said, alluding to that experience, “I’m here to change the trend, too. The trend I’m altering is my financial life. I’m going to create a new lifestyle for myself—financial ease.”

Betty was aglow as if some sort of positive electricity were rippling through her. I could tell instantly that she had made some changes for herself.

Credit Cards and Financial Plan“So tell me what you’ve done,” I said.“I torched my Visa,” she said with a huge laugh. “Women before me burned their bras. I burned my credit card. It felt good!”

“Good show. Now you’re really taking charge.” I gave Betty a hug and sat down with my yellow pad to jot down some notes. “Okay. Let’s get to work. What do you have?”

“Well,” she began, fingering some pages in a folder, “I have my 401(k) plan, which has about $25,000 in it, and an IRA I haven’t funded for some time.”

“How much do you have in the IRA?” I asked.

“I think about $5,000. I also have an insurance policy that my father gave me and $10,000 in my checking account. Would you please go over the file cabinets with me again and help me understand what my financial picture looks like? I need to see how these investments will fit into the drawers.”

“No problem. Let’s run through each of the file cabinets and see how it all sorts out for you,” I said. “Our objective is to figure out how much cash will be coming to you in the future and what its source will be.  Remember, I don’t want you to be singing the blues as a bag lady when you can be crooning your wisdom and joy of life in your later years!”

     Remember, I met Betty at the Ranch.  And I was thinking at this moment of the woman who is 93 now, who started this soulful-healing-beauty retreat many years ago with her husband.  Today, at 93, she is leading “Wellness Warrior”, living her mission to see all of us live consciously about health for ourselves and our planet (  Now, this is a woman who serves as a model to all of us for fulling living our lives and putting our messages of service into action — she’s 93 and still engaged! I sat in that space for Betty to live her passion too with the resources that support her life.

     I pulled out my drawing of the three file cabinets and began to construct the landscape of Betty’s financial life. The picture showed the three filing cabinets: each with the same three drawers stocks, bonds, and real estate.  I began to see how Betty’s money and life would blossom.

File Cabinet No. 1: Taxable Investments

At the moment, Betty has no investments in this file cabinet. She does have some cash that is sitting uninvested in a “To Be Filed” basket next to the cabinet—the $10,000 in her checking account.

Financial PlanLet’s say she did have investments in this file cabinet. What would they likely be? She might have a piece of rental property in her real estate drawer. She might also have opened a brokerage account and purchased some stock, which would be in her stock drawer. This type of investment account can be opened through a brokerage firm, an investment adviser, or even an online computer service that allows you access to purchasing stock.

Here’s how opening a brokerage works in a brokerage firm. We give you three forms to fill out. The first asks for general information, like name, address, and Social Security number. The second form is an agreement of understanding that you’re opening an account. The third is an IRS form that verifies your Social Security number for tax purposes. That’s all there is to it.

Opening a brokerage account is as easy as opening a checking account at a bank, and once it’s set up, you can deposit money into the account and use it to make purchases, like individual stocks and mutual funds. The account also includes a money market fund—an investment in short-term corporate debt that pays interest to shareholders. So as long as your cash remains in the account, it earns interest at the money market rate, which later can range just around one percent per year.

Betty’s cash is not earning interest in her checking account. By simply moving it into an investment account, money market interest will be generated. The highest money market rates are paid by brokerage firms, not banks. When you open your investment account, ask what the money market interest rate is. But remember, a money market fund is a short-term tool. Even though it’s earning interest, I don’t consider it an investment for your long-term financial growth. A money market account is simply a holding pen for your cash until you hatch an investment plan so your cash can build up your Money Machine.

That’s where Betty is at the moment with the money she has in her checking account. Should she choose File Cabinet No. 1, 2, or 3 to invest this cash? We first discussed File Cabinet No. 1.

“How do you want to be taxed? Remember, this file cabinet is not protected from taxation. You are taxed across the board; dividends and interest are taxed, as is any gain from the sale of your investments,” I said.

Betty frowned. “Frankly, I don’t want to be taxed at all,” she said.

“Of course not,” I said with a laugh. “But before you get too concerned about giving up money to Uncle Sam, keep in mind that if you get a good return on your investment, you can afford to pay your taxes and still come out ahead. This file cabinet has its place, but we won’t make any decisions right now. Let’s see how it fits into your investment strategy and examine the other two file cabinets.”

“Fair enough,” Betty replied.

File Cabinet No. 2: Qualified Plans

     Qualified plans are special accounts that Uncle Sam has agreed to defer taxes. These include traditional IRAs, 401(k) plans, 403(b) plans, company pension plans, Keoghs, and SEP-IRAs (simplified employee pensions). A SEP-IRA works like an IRA, but a SEP-IRA allows a self-employed person to make higher tax-deductible contributions. Self-employed people, as well as corporations and partnerships, may also use Keoghs. They permit employers to contribute up to 15 percent of all employees’ compensation to an employee’s saving plan. 401(k) plans, 403(b) plans, and company pension plans are also made available by employers.

     Important distinction:  If you use a qualified plan, your money goes into your plan tax-free and grows tax-free. However, you will pay a full tax at your regular income-tax rate when you withdraw money from any of these plans. If you’ve steadily mushroomed your account to, say, $250,000, that sum will be considered income when you withdraw it. Let’s assume that you’re combined state and federal income tax rates will be roughly 40  percent.  When you’re ready to use that $250,000, you’ll pay about $100,000 to Uncle Sam when you withdraw your money, and you’ll realize only $150,000 of your investment. As of September 2015, there are seven tax brackets or personal taxes:   10%, 15%, 25%, 28%, 33%,  35% and 39.5%. and you’re withdraw from your qualified plan will be taxed at one of these rates.  (

     Please remember the retirement income-tax myth we discussed the article ‘Money Advice for Financial Plan and 401KWomen: What Holds Us Back”: “A sound investment program rests on the inevitability that the investor’s taxes will be lower after stopping work.” If you continue your current lifestyle, your tax rates are likely to be the same; they may be even higher because tax rates are rising. If you are willing to significantly cut back on your spending and carve out a bare-bones existence, maybe you would have lower taxes.

We cannot predict what taxes will be when you reach the age at which you will plan to withdraw your contributions, but one thing is certain: Cash paid to you from your qualified plan will be treated as taxable income, as your salary was before you stopped working. Suppose you earned $50,000 a year when you were working and paid a certain tax on that income. If you have the same income later, you’ll pay the same amount of tax on the $50,000 you withdraw from your traditional IRA once you stop working, assuming the tax rates are the same.

Qualified plans used to work better. That’s because there was a time when people were more likely to be in a lower tax bracket during their nonworking years. The simplification of tax brackets and changes in the marginal tax rates (the highest tax rates that may be applied to income) have altered that reality. Furthermore, Congress controls the rules by which such plans work, and it has changed these rules hundreds of times in the past few years and thereby further complicated the picture. The bottom line is that between tax rates and the mercurial nature of the rules for qualified plans, it’s difficult to know how much you’ll receive from these plans when you’re ready to withdraw your money and maintain your lifestyle.

Another challenge posed by qualified plans is that they often limit how much money can be contributed to them; thus they will often be unable to generate enough cash to maintain your preferred lifestyle. For example, if you’re now forty-five years old and you can contribute only a maximum of $2,000 a year to an IRA, you won’t have enough by the time you stop working. Even Keoghs and 401(k) plans, with their higher contribution limits, offer only a partial answer to designing your financial future.

Betty already has some qualified plan investments: She has $25,000 in her company 401(k) plan and $5,000 in her IRA. In which drawer of File Cabinet No. 2 does she have her 401(k) plan?

“Bonds,” she said. “Government bonds. Someone once told me they were safe. But they seem so sluggish right now.”Betty was questioning the rate of return on her bond investment. She already suspected that bonds were not going to afford the best yield to grow her Money Machine. And her 401(k) is the largest bundle of cash she has working in her Money Machine. Her IRA, however, is in the stock drawer, invested in a mutual fund of worldwide stocks.

An investment or brokerage account for any of these qualified plans can be opened in a similar way to the process described for File Cabinet No. 1. It’s generally the same three forms we spoke about for investing in File Cabinet No. 1 plus a fourth form, which is an agreement of understanding that you’re opening a qualified plan investment account. One of the government-imposed conditions of this type of account is that you can’t withdraw money from your qualified plan until you reach age fifty-nine and a half. Your money will be taxed if you withdraw it before then, and the IRS will slap a 10 percent penalty on whatever funds are removed.

If you have an IRA at a bank, you can move the cash and investments in your IRA bank account to an IRA brokerage account. If you have left a company where you invested in a 401(k) plan or a pension plan, you can also transfer those investments to your IRA brokerage account. In both instances, you will have more flexibility in managing your money and more flexibility if you can consolidate two or more accounts into one. Don’t worry about sacrificing diversification. Since you’ll have a variety of investments, you won’t have all your eggs in one basket. And you will receive information about your investments in a single monthly report rather than in two or more statements, which you would have to track down and interpret.

In the end, you’ll probably want resources in each of the file cabinets to construct your Money Machine. This way you’ll build a composite of investments with different methods of taxation.

File Cabinet No. 3: The Private Pension Plan

Betty also has a beginning resource in this file cabinet: the cash value of the life insurance policy her father gave her.

“This file cabinet really has my attention,” she said, “because it can give me back money tax-free.”

Pension Fund and Financial PlanFile Cabinet No. 3 can provide Betty’s dignity money. This file cabinet allows you to grow money tax-free and to withdraw it tax-free—a real benefit in planning for the essentials of your future. Plus, unlike qualified plans, investments in this file cabinet impose no restrictions on who can own such an investment and no limits on how much you can invest.

This file cabinet is the private pension plan, which also is known by its more technical name, the flexible premium variable life insurance plan. From now on, we’ll simply call it the “PPP.” It is a combination of variable insurance and mutual funds. The primary aim of this investment is to take the best of what insurance has to offer— the ability to grow money tax-free and to withdraw it tax-free—and the best of what mutual funds have to offer—the historically high rate of return of stocks—and to unite them to grow money.

You might balk at the mere mention of insurance. But that response is based on an antiquated point of view. Many people believe that insurance should be bought only to provide a death benefit in order to protect those you love. This was the role of traditional insurance, and the power of insurance as an investment vehicle was indeed limited. However, insurance can now be used to bet that you will live a long time and will need some real-life benefits. As you’ll see, if you own mutual funds and insurance, you’re missing an opportunity if they are not working together. If you do not combine them, you will pay the cost of insurance and the tax on the dividends and capital gains from your mutual fund. The wealth-building strategy is to unite the two and cut your costs.

The private pension plan file cabinet has the same three drawers as the other two cabinets: stocks, bonds, and real estate. You can own the same mutual fund in File Cabinet No. 1, and be taxed on both the dividends and profits you make from it. You can own it in File Cabinet No. 2, and pay tax on it when you withdraw money. Or you can own it in File Cabinet No. 3, where you will have already paid taxes on the cash before you put it in, and you can remove your cash tax-free.  If you are young enough, a Roth IRA will work this way for your too.

In a perfect world, there would be a File Cabinet No. 4, in which taxes would never come due—Uncle Sam would just go away and forget about filling his pockets. But if you remember how money grows—the eighteenth hole in the game of golf was worth $13,800—then you’ll see that paying tax on the back end, particularly when you can’t pin down the tax rate, can be a costly choice. Your better alternative is to pay the tax on the seed rather than on the harvest.

Throughout history, people have secured their futures by receiving tax-free income, often through tax-free municipal bonds, so that they could be certain how much income they would receive free from Uncle Sam. This allowed them to plan for their future lifestyles and not be burdened by the complexities of taxes in their later years. Today, the PPP works as the municipal bond once did. (Also, the new “Roth IRA” gives you some limited opportunity to grow your money tax-free and take it out tax-free.)

As the “variable” part of “flexible premium variable life insurance plan” implies, the returns from investments in the plan are variable because the stock market can go up or down. The “flexible premium” part means that you can put different amounts into your plan in different years if you choose to do so. The “life insurance” part refers to the term insurance that wraps the plan. As required by all insurance plans, you must show good health—part of your Wheel of Life—before you can set up the plan.

I discussed all of these factors with Betty so she would have a basic understanding of the PPP. But she was still skeptical about the tax-free nature of withdrawal.

“How do you do it? How does that work? I mean, it’s a miracle to extricate anything tax-free,” she exclaimed.

The answer is easy. As far back as your great-grandmother, or even her mother, people owned insurance policies in which they had socked away some extra cash. If they needed money at some point, they could borrow against their policies—ttax-free. It’s this ability to “borrow” money tax-free against a life insurance policy that enables you to withdraw funds tax-free from a PPP, because when you withdraw cash from your PPP, you are technically “borrowing” it against your insurance policy. But the major difference between the PPP and conventional life insurance policies is that if you borrow money against a traditional policy, you have to repay it. If you withdraw money from a PPP, you never have to repay it. Instead, “the net surrender value” of your policy is reduced by the amount you withdraw, as are the lump-sum death benefits to your heir or heirs.

“Joan, I am very taken by the PPP, and I’m definitely going to apply for one. But why haven’t I heard about this before?” Betty asked.

“Not many brokerage firms and only a few insurance companies can tell you about this type of investment because it takes expertise in both areas to create it,” I said.

But the field is expanding rapidly. Investors are becoming aware that qualified plans aren’t working as well as they once did. In response, brokerage firms are creating their own PPPs, and insurance companies are pairing with mutual funds to create them. The PPPs offered by each of these companies differ widely. You can evaluate three essential factors to make sure that you’re choosing a good plan:

  1. Is the borrowing rate to take money out of your private pension plan less than .5 percent, and is it guaranteed for life?
  2. Do the mutual funds offered in the plan have a five-to-ten year record of an annual average return of 12 percent or better?
  3. Are the term insurance costs about the same as or lower than those of other plans?

If the answer to all three questions is yes, you’re on the right track.

The beauty of File Cabinet No. 3 is that you can have a private pension plan even if you also have qualified plans in File Cabinet No. 2. So if like Betty, you have a 401(k) plan, but you know that it’s not going to produce enough cash for you, you can also have a PPP.

Also, the private pension plan belongs to you, not your employer. That means that when you change jobs or move across the country, your PPP goes with you. You own it, you are completely responsible for setting it up, funding it, deciding when you’ll take cash out of it, and matching it to your lifestyle.

For example, let’s say you’re forty-five, and you have been funding a private pension plan since you were thirty-five. You decide to quit your job and take time off to travel for a while and work on that novel you have always yearned to write. So you stop contributing to your plan, take out some cash so you can live for a few years, finish writing your book, go back to work, and start putting money back into your PPP until you’re sixty-five. The plan is that flexible.

You also do not report it on your tax return (you are not mandated by law to do so), so it is not apparent to Uncle Sam that you are accumulating this cash—and it might be substantial cash. Those who are concerned about financial privacy find this feature attractive.

If you have a domestic partner, the private pension plan solves the problem of how to leave your assets to him or her. In your PPP, name your partner as the beneficiary and, by law, she or he will receive the wealth from your plan tax free.

Again, setting up a private pension plan entails filling out some forms, obtaining approval for insurance coverage— approval requires a medical review—and then setting up the investment account. It’s your decision how you wish to pay into your plan. You may choose to have monthly deductions made from your paycheck, or you may simply write a check quarterly, semiannually or annually. Once you’re in motion, just plug in the money and watch it grow.

Building Betty’s Financial Plan

“I get the picture,” Betty said. “Basically, my money is now grouped in choices from File Cabinet No. 2, which includes my IRA and my 401(k). My $10,000 is cash-in-waiting. And what about the cash that’s in my insurance policy? Is that a private pension plan?”

“Not yet,” I responded. “But it’s a start.”

What Betty has is the old type of insurance. Her father probably bought it for her for protection. By converting that old plan into a new form of insurance, it will continue to include protection coverage, but will primarily be an investment to grow money tax free. The big difference between the two types of insurance is that the cash in her old policy is earning money at a small interest rate, a rate that the insurance company established some time ago. The new form will invest her money in mutual funds in order to take advantage of growth in the stock market, and, as you now know, that makes a tremendous difference. This explains why insurance was never considered to be an investment. Today, though, it’s a primary tool in the good growth of your money.

“Just as we can move an IRA from one location to another, we can move cash from your old insurance policy to a new one,” I told Betty. “So this policy your father gave you could be the start of your new private pension plan. It could be a File Cabinet No. 3 stock drawer investment.”

“Okay. Let me figure this out. I’m forty-two years old. If I assume my money will grow at a 12 percent rate of return, then according to the Rule of 72, it will double every six years. That means that, until I’m sixty-five, my money has the potential to double about four times,” Betty pondered.

“I see where you’re going,” I said. “You want to know how much you’ll have in your IRA and 401(k) plan by the time you’re sixty-five, right?”

“Yep. I’m wondering what life will be like then,” Betty said. “Let’s see—$25,000 in my 401(k) plan and $5,000 in my IRA. That’s $30,000 invested right now. So using that doubling rule, if my money doubles four times, then my $30,000 turns into $60,000, which turns into $120,000, and that turns into $240,000, then $480,000. Wow! I’m going to love watching that money grow.”

“If, at age sixty-five, you have half a million in an investment that pays you 8 percent per year, your investment will give you an annual income of $40,000,” I added.

“Yes. But remember, Joan. You said that Uncle Sam was going to want to collect his tax. So if I assume that combined federal and state taxes will be around 50 percent when I reach sixty-five, I’ll actually have only $20,000 to spend each year. My problem is, that’s not going to be enough for me to do the things I’ll want to do at that time. But it’s a start, and I’m glad I’ve done as much as I have, because at least with this, I realize I will be able to meet my essential needs—my dignity money. But the other thing that concerns me is that, in twenty-three years, $20,000 isn’t going to have the same spending power as it does now. I need to do some more investing because I haven’t built my Money Machine to where I want it to be,” Betty concluded.

     “And where do you want it to be?” I asked. “Oh, somewhere in the neighborhood of $150,000 a year,” Betty said. “Well, that’s a real nice neighborhood. But tell me: Is that $150,000 after taxes?”

“Why not?”

“Okay. Let’s work this through,” I offered. “If we take that $10,000 that’s sitting on top of File Cabinet No. 1 and make a plan, you can get there. Can you also invest a new $10,000 each year from your earnings?”

“I should be able to. I make a good salary, and there are expenses I can readily cut out, like cab rides, extra clothes, and a few dinners and lunches here and there. And this is important to me, so I can figure out a way to create some side income.”

“Well, I sure hope you aren’t going to start working eighteen-hour days again to get that extra cash,” I said.

“Oh, no,” Betty replied. “I want to put some distance between me and my office. What I had in mind was selling my pottery to some of those little shops in the Bay Area, Santa Cruz, or right here in Los Angeles,” she said. “The work would give me great pleasure.”

“I think you’ll have a ready market for your work—people around here just adore handcrafted items—plus you will be adding joy to your life,” I said.

So this is what Betty did with the $10,000: She kept $2,500 in her checking account as a cushion, stashed $2,500 in a money market account for unusual expenses, and invested another $5,000 in the 401(k) plan offered by her employer. The most important reason for this last move is that her firm matches her contribution by depositing into her account 35 percent of what she puts in each month. A 30 percent or more match makes it worthwhile to use the 401(k). However, if your employer does not match your contribution, or if you are the employer and you have the additional cost of maintaining such a plan and funding it for your employees, then a 401(k) or other qualified plan makes a lot less sense.

Notice that Betty has made no additional contributions to her IRA. She’s allowing the $5,000 she has invested in it to remain as is.

Next, Betty took the cash in her old insurance policy and some money from her salary and started a private pension plan. She’s committed $10,000 a year to her plan; the money will come from her earnings. By investing through age sixty-four, and projecting an average annual return of 12 percent on her investments, she’ll get good results from her PPP. We projected that she will create a cash flow for herself of about $89,600 a year, tax free, from age sixty-five until age eighty-five. Also, she’ll have $633,831 in life insurance for protection right from the start.

The life insurance will also go to her beneficiary tax free, and this is useful in estate planning. If you plan to bequeath someone a piece of property, it’s a good idea to also leave some insurance proceeds to them so they are not forced to sell the property in order to satisfy the IRS, which will demand an estate tax payment ninety days after the inheritance. Betty also committed to doing a will.

By this time, Betty was on a roll. “Let’s see,” she said, “I’ll move the $25,000 in my 401(k) plan out of the bond drawer and into the stock drawer to best grow my money. Then, if I have $24,000 a year from my investments in File Cabinet No. 2 and $89,600 from my private pension plan in File Cabinet No. 3, I’ll have about $113,600 to spend free of any taxes when I’m sixty-five and well into my nineties. It’s not the $150,000 I set out to get, but I like it! Now I really want to live a long life.”

Betty’s Money Machine will be churning and burning, and she certainly won’t be out working until she’s seventy-five just so she can pay her bills.

Betty has successfully tackled her personal money matters. She can make a good estimate of the cash that will come from her Money Machine when she’s ready to depend upon it. As she goes along and monitors the actual results from her investments, she’ll continue to revise her projections. But now that she has this plan, she has only two jobs left. One is to invest regularly, and the other is to watch that her investments are growing on the average of 12 percent a year. And there’s a third: to smile, knowing that she’s handled this part of her Wheel of Life.

“Let’s see. I pick the file cabinet depending upon how I want to be taxed, and I pick the wave of the future for my stock drawer. And then I stay planted, and try not to outsmart the market or get persuaded by hype. Is that it?” Betty asked.

“That’s pretty much it,” I responded. “And you’ll build your Money Machine your own way for your future.”

“I can’t tell you how relieved I feel,” Betty said. “For several months, I’ve had this terrible, edgy feeling. Now I’m feeling better, much better.”

The lines in Betty’s face had relaxed for the first time since I met her. Her skin had a glow, and she sparkled as much as the yellow tulips she had showered me with.

She left knowing the specifics of how she would derive $113,600 a year from her Money Machine into her nineties. I suspected that with that sense of security, her entire Wheel of Life was going to roll along at a new and energized clip.

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