Year-End Financial Check Up

Hey, what's up everyone, Henry here from Disruptive Money Management, and my oh my, I cannot believe that it is already November. In the blink of an eye, we will be ending 2021 and starting the year 2022. It feels eerily strange how fast this year has flown by. It seemed like the pandemic environment slowed things down for a while, but it felt like time sped up instead as things progressed.

Here we are, almost at year-end, and I thought it would be an excellent time for us to go over some year-end financial steps you can take to prepare yourself for the path to financial independence.

Additionally, I've been getting a lot of inquiries about the importance of trust in financial planning. I've brought up the trust numerous times in my episodes on things you may want to consider, and for those that have reached out on wondering when you need to have a trust set up and how it ties into estate transfer, we are going to be going into that subject here as well.

So today's episode will cover not only just year-end financial steps but also the usage of the trust and whether it is right for you. So be sure to stick around to the end, as we have an episode with a ton of great information for you to take away and incorporate into your own financial life as you move down the line towards financial independence.

You know, I have to say that this year was not dull and I think you also feel the same way for many. For the people I have had the opportunity to speak with, many have told me of the success they have seen amid the chaotic times we live in.

With the ongoing labor shortage becoming a significant issue, those who are gainfully employed are finding that they are busier than ever. Many are clocking in overtime, and those on salary are seeing bonuses higher than ever before. Corporations around the country are struggling to retain talent and are doing everything in their power, including monetary incentivization to keep hardworking, loyal employees.

Many of my corporate clients are in manufacturing, and it wasn't that long ago, at the beginning of the pandemic, that many of them were concerned they would have to lay off staff to stay afloat. The complete opposite scenario is happening with work orders coming in quickly and businesses seeing their valuations soar.

It's safe to say that becoming sidetracked during these quick step times is easy, but I implore you to take a moment to catch your breath and assess your situation. Your financial check-up should start first and foremost with how you have done this year.

In comparison to the previous year, has your earned income gone up? If the answer is yes, what steps have you taken to help shelter some of that additional income from increased taxes?

Here's the thing, while making more money is fantastic, we often forget that with more earned income, there is also a greater tax liability. Or maybe it isn't that we forget, but we instead get so busy working that we fail to acknowledge that we need to do something about it.

If you are in that category, I implore you to first and foremost check and see how much you have contributed to your employer-sponsored 401(k) plan.

The maximum you can contribute to a 401(k) is $19,500, as well as an additional $6,500 in catch-up contributions if you are age fifty and older. There are many that I have come across who are earning high incomes and paying high tax rates but have failed to contribute the maximum to their 401(k). Unfortunately, many fell into this category primarily because they only focused on the company match amount. Most companies typically provide a 4-6% match depending on the employee contributing a similar amount. Often, many would just start at that lower number because they wanted to capitalize on the match, but they failed to increase the percentage as their salary increased.

If you have not maxed out your 401(k) yet, take this opportunity to see how much you have contributed and see if you can fund your 401(k) account by year-end fully. Remember that at this point of the year, you might only have four or five pay cycles remaining, and while most companies will have no problems with you contributing all of your paychecks to your 401k, time is not on your side, so making these changes quickly is crucial.

Now, of course, it goes without saying that contributing all of your paychecks would mean that you won't have any additional income for the remainder of the year, which is why this strategy only works if you have banked the extra you made this year. I've worked with numerous individuals through this scenario these past two months where they are sitting on large sums of savings because of the extra overtime and bonus pay. The idea is to utilize those funds to pay for your remaining living expenses for the year instead of earned income from the following four or five paychecks.

Come January; you're going to want to decrease that contribution percentage back down to a more comfortable amount. For instance, you have contributed 5% of your salary and are bumping that up to 25% of your paycheck; you probably won't want to start January off by contributing 25% of your salary to the 401(k).

At that point, bring it back down to whatever number it is that you are comfortable with. You might want to bring that up to a value where you can contribute the maximum throughout the year instead. Note that for 2022, the maximum 401(k) contribution is being bumped up by a thousand dollars.

So what options do you have if your employer does not offer a 401(k)? Well, if you're self-employed, you can set up your own 401(K). An Individual(k) has the same functionalities as an employer-sponsored plan but is designed for freelancers, gig-workers, and self-employed entrepreneurs without any employees. You get to contribute the same amount as an employee, and you also can contribute as the employer.

The maximum that self-employed individuals can contribute to an Individual 401(k) is $58,000, not including catch-ups. This is an absurd amount of money that can be sheltered in a pre-tax account, thus effectively decreasing your tax liability by a significant amount.

Please note that to contribute for the calendar year 2021, you need to have the Individual 401(k) account established by year-end. Your employee portion of the self-employed earnings, or the $19,500 instead, must be deposited by 12/31. The employer portion has a later deadline. The employer portion, calculated at 25% of compensation, is due by your actual tax filing timeframe. That means April 15th and any extensions filed.

For more information on the Individual 401(k) and whether it is right for you, be sure to check out "Retirement Savings for Solo Entrepreneurs," which highlights the plan details.

If you need more deferrals than the $58,000 allowed within the Individual 401(k), then be sure to check out my episode "Why The Defined Benefit Plan is The Single Greatest Investment Vehicle for Business Owners and Self Employed Individuals." While the DBP is not for everyone, it is an additional pre-tax account that can provide up to 125% of earned income in deferrals. Again, a link to that podcast episode will be delivered within the show notes.

Contributions to the Traditional IRA and Roth IRA can still be made through April 15th if you need additional deferral room or you just want to maximize the amount you can put towards your retirement. If you're married and a sole income earner, you can defer not just to your own but also to your spouses' IRA account.

Before you jump into the new year, be sure you set your financial plan right by reviewing your budget and spending habits. By now, you should be able to look through your statements and quickly determine where your money has gone. If you do not have a budget yet, structuring one now will mean you can better control your expenses instead of just spending it willy-nilly.

By setting up a budget and having it detailed out, you can better assess where your money is going, which leads to the next step of setting your financial goals for 2022.

Be confident that you set financial goals for the year as opposed to just running into it blindly. Whether building up a savings account, max contributions towards your retirement plan, or jumpstarting your kids' college tuition account, you want to go over your savings goals by writing down exactly how much you feel you can contribute to those areas and setting up the automatic transfers.

Reviewing your insurance coverage and beneficiary designations is also an excellent financial step to take during this time of the year. I can tell you from personal experience that many do not actively go into their 401(k) accounts and add the appropriate beneficiaries.

When it comes to insurance coverage, checking to ensure you are adequately covered on life insurance is a crucial first step as you work towards building your wealth. Remember that life insurance is a stop-gap between where you are now and where you want to be and should only be used as such. For that, I recommend term life insurance and having enough coverage on both your life and your partners.

Not having the correct beneficiaries on your investment accounts could delay the transfer of funds in the event of unexpected death. Perhaps you recently got married or had another child. Whatever it may be, make sure you address the changes in beneficiary information from where it was before and where you want it to be now.

In addition to checking the beneficiary list, you should consider whether establishing a trust is an appropriate action for you. The trust is not necessary for every individual or family out there.

The most common structure of the trust and one that you may want to implement is the Revocable Trust. The Revocable Trust is one that you establish to have ultimate control over how the assets are disbursed.

I'll give you an example of two hypothetical scenarios: one with and one without a trust.

In our first scenario, John and Jane Doe are both entirely comfortable with their assets being transferred directly to their children upon their passing. Their children are old enough and responsible enough to manage their finances. Because John and Jane do not need any additional control but only want to guarantee that assets are transferred seamlessly, they are perfectly fine with having their children listed as contingent beneficiaries on all of their retirement savings accounts.

Additionally, they have taken the necessary steps to add the children to their bank accounts via a TOD (that's Transfer on Death) agreement. When it comes to their primary home, they have also recorded a beneficiary deed with the local county recorder's office.

Finally, they each have their own will that stipulate how personal items should be distributed amongst the children. With these three steps, John and Jane are adequately covered from a transfer of assets perspective. In this situation, it's unlikely that a trust is necessary.

That scenario is generally expected for individuals in retirement and has a relatively easy estate. What happens when it gets more complicated? Imagine this:

John and Jane Doe have accumulated a significant estate through their working years. While they are both relatively healthy, they have concerns about how their assets will be divided amongst their children. The circumstances are not about equal division but about how the children will be given specific components of the estate.

For instance, it is important to John and Jane that their son retains majority deciding ownership of the business they have built. The reason for this is because their son John Jr. is the one who has been working diligently to run the business while John and Jane slowly phase themselves out.

Since John Jr. will be inheriting the business, John Sr. and Jane want to ensure that their other two children receive an adequate amount from their investable assets and the properties owned by the couple. Their idea is to provide the remaining two children with a property each and any additional cash from their investment accounts with a valuation equivalent to 25% of their business valuation. They feel that it would be fair to provide each of the two remaining children with 25% of the business valuation in other assets outside of the business.

Lastly, John and Jane Doe are adamant about providing a trust fund that benefits their young grandchildren. They want to ensure that their grandchildren receive $100,000 each upon John and Jane's passing, invested and held in a separate account for them. The individual grandchild can only utilize that account for medical and educational expenses.

Upon turning age 25 and successfully obtaining a degree in higher education, the grandchild will automatically inherit the total valuation of what that $100,000 has grown to. This type of "kick-start their life" account is significant to John and Jane because they want their grandchildren to have a semblance of financial security early on.

As you can see, this second scenario is not as easy of a transition because John and Jane do not necessarily want all of their accumulated assets just to be given to the beneficiaries. Due to the more significant estate and more complicated structure, they want to maintain a better control factor upon their passing instead of direct distribution.

You know you'll need a trust when control or fairness is not easily obtained. In that regard, you'll want to work with an experienced estate planning attorney to help you properly draft the necessary trust documents outlining all of your wishes.

Having the trust is only as crucial as utilizing it, and that means going out to re-title your assets in the name of the trust. Additionally, you'll want to list your trust as the direct beneficiary so that assets are appropriately transferred to the trust upon your passing. Assets that are not naming the trust as the direct beneficiary could be contested and may follow their own rules instead of your stipulated guidelines.

Keep in mind that having a trust is not necessarily just for those with a significant net worth. Remember, it is about control. If you and your partner are both in your thirties and have young children to care for, you may want to consider having a trust if you expect to need control of those assets upon your passing. Perhaps you have a significant amount of company stock that is vesting soon, or you each have a significantly large amount of life insurance to protect your children upon your passing. Rather than having the life insurance go directly to a transfer account, you may want it controlled based on your stipulations.

All situations are unique, but a quick assessment of where you are and where you want to be financially will help you determine what appropriate steps are needed. As we close out this year, I urge you to take a moment to reflect on your financial situation and have a conversation with your partner about what your wishes, dreams, and goals are for the upcoming year. Don't wait until January 1st because by then, you'll be inundated with all of the new year activities that come about. If there's one thing these past two years have taught us, it is that life moves quickly and how your financial future looks like is now in your hands.

And that's for it today, my friends. I hope you enjoyed this episode, and I wish you and your family the very best.