Wealth Protection: Risk and Tax Management

Risk Management
Every day we are exposed to many risks which can cause a financial loss. Accidents, property damage, illness, and death are risks we often consider. However, other risks, such as the possibility of being sued or becoming disabled and unable to work, are also important. We each have to decide how we will protect ourselves should a risk become a reality. If you do not have a plan, you might have to go into debt or use funds set aside for other financial goals in the event of financial disaster.

Appropriate risk management strategies protect against catastrophic financial losses, regardless of the cause. Good comprehensive insurance coverage against severe setbacks is essential. Areas for coverage include life, health, homeowner. s or renter. s, auto, disability, and liability. Smart consumers can obtain this coverage at a cost that allows them to move up the pyramid to accomplish other goals without being insurance poor. Note that this type of risk management should not be confused with investment risk, which is a different financial concept.

To determine when you need to purchase insurance, consider the best way to handle each of your risks. Because your risks change over a lifetime, evaluate your situation every few years and make appropriate changes. Can your savings cover a financial loss so that you don. t need to buy insurance? Increasing the deductibles (the portion of a loss that you pay) on your policy usually saves you money as well. However, when self-insuring or carrying high deductibles on policies, you must set aside the necessary funds in your emergency cash reserve to pay for those expenses in case of a loss.

Risk management strategies can be combined with savings and investments to achieve financial goals (e.g., buying cash value life insurance). However, be careful to ensure that your strategies provide the best return on the money involved. Determine if insurance protection can be purchased less expensively so that you can invest the savings for a greater overall return.

Tax Management
The goal for taxpayers is to pay no more than the least possible tax owed. Avoiding taxes through legal tax strategies is not to be confused with illegal tax evasion. Legally avoiding taxes means using effective financial record-keeping, decision making, and planning strategies to reduce your total income tax . One example of good tax management is adjusting the amount of federal income tax withheld from your paycheck. If you receive a big income tax refund (over $500) each year, you are giving the federal government an interest-free loan. Evaluate the amount you have withheld and determine if you could use this money more effectively throughout the year to manage cash flow or invest for financial goals.

Tax laws continue to dictate how we structure our financial plans. As laws favor or disallow certain strategies, we need to make adjustments. Two examples of this phenomenon are Individual Retirement Accounts (IRAs) and home equity credit-line loans. When everyone was allowed a tax deduction for an IRA, this strategy was widely encouraged and used. Since tax laws restricted IRA deductions, many people automatically eliminate them as a viable alternative. Now that tax deductions for non-mortgage consumer interest are not allowed, many people have turned to home equity credit-line loans to finance large purchases and deduct the resulting interest.

As tax laws change, adjust your financial plans to use strategies which are most favorable to your situation. Most of us are aware of the tax advantages of tax-deferred savings. The idea, of course, is to put off paying income taxes on money until you withdraw it in retirement when, possibly, your tax bracket may be lower. However, you have no guarantee that this will happen, especially if you are very successful at saving for retirement and accumulating assets. In addition, the tax laws are constantly changing. You should seek the advice of a Certified Public Accountant (CPA), Certified Financial Planner (CFP), or tax professional to gain insight into how tax laws will affect you.

For example, under a tax law effective May 7, 1997, up to $250,000 of profit from the sale of a primary residence is tax-free if you file an individual tax return; up to $500,000 if you and your spouse file jointly. To qualify for this tax-free benefit, you must own and live in your home for 2 of the 5 years prior to the sale. Only one spouse is required to own the home, but both need to have lived there to qualify for the larger $500,000 capital-gain tax exclusion. Further, you can use this new exclusion even if you have previously claimed the old $125,000 exclusion. How often you use this new exclusion is unlimited, but generally you can qualify only once in any 2-year period. If you must sell a home because of ill health, a job-related move, or unforeseen circumstances prior to meeting the 2-year test, you can claim a prorated exclusion.

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