Where’s my bailout? Featured

8:00pm EDT June 25, 2009

Many investors have lost a substantial part of their savings and the possibility of future tax increases and market uncertainty is making business owners rethink the way they save as well as the types of benefits they offer their employees.

“We’ve obviously seen markets go backward. We know based on current tax laws that without even changing legislation, tax rates are going to increase,” says Josh Cobb, vice president, Peachtree Planning Corporation.

Many experts have predicted that the proposed massive increases in government spending will lead to higher inflation in the future. Smart investors can prepare for these future increases by using strategies that coordinate their personal tax and estate planning with insurance and tax-free investment products to help reduce their future tax liabilities.

Smart Business spoke with Cobb about what the future of investments may hold.

Will the products we are using for savings have to change?

Yes, from a strategic and tactical standpoint. Consider the 401(k): It was designed to help workers systematically put away money to create a stream of retirement income. The idea being that you should avoid paying taxes today and withdraw those funds in the future at a lower tax rate. If taxes rise in the future, you lose much of the benefit you gained by deferring those taxes.

If I were 59 years old today and I was going to retire next year and we knew tax codes were going to expire and tax rates would go from 35 percent to 39.5 percent, would I defer any money this year? The answer would be no. You’d have to be crazy to do that. Tax deferral compounds your savings, but it also compounds your tax liability.

What advice can you give business owners who are concerned about their savings?

It’s not always a bad thing to pay a tax today and be done with it. For example, if you were to call a traditional accountant, they may tell you to maximize your pretax deferral strategies. You’re hiding the tax but only for it to be uncovered at a later date. Then, you have no idea how the deferred amount is going to be taxed.

So if you contribute an after-tax dollar into a strategy, you should consider whether that strategy will be taxable or nontaxable. If you choose to use an after-tax strategy, perhaps you should look at the available products that could avoid tax altogether.

I always ask clients, ‘What’s more important, the product or the result?’ A lot of people have this stigma that a product can only do a certain thing. Our premise is that it’s not really the product, but it’s the strategy that’s important. It’s more like a game of chess. We have to work with strategy, the pieces and where those pieces are in relation to the strategy.

What types of products can avoid tax?

Based on the current tax code, insurance is technically treated as a tax-deferred vehicle. If it is used and distributed properly, you’ll never be subject to tax. We have tax-advantage security products, i.e. municipal bonds. We can buy individual stocks if we choose to, hold them in perpetuity and potentially work on a charitable giving strategy so we’d never be subject to long-term capital gains tax.

These strategies might not be appropriate for everyone. Each strategy must be tailored to fit the individual investor’s specific situation.

We have to begin from the standpoint of what it is that we are trying to do, what you already have, and what you’re already doing. At the end of the day, the financial decisions must be in alignment with the intentions.

How can potential investors know if a product is right for them?

Before we make any recommendations, we begin with a complete analysis of a client’s current situation. I’ve found most business owners’ primary problem is lack of time. They tend to have very limited time apart from what they’re doing in the day-to-day operations of their business. We start by getting them organized and making sure they have a complete understanding of what they own and why they own it. Many times, they realize they don’t know exactly what they have or what it will do for them.

If you already own these products, what should you do?

You need to understand the products you own and the types of vehicles you are using for savings. For example, if you own a permanent life insurance product, i.e. a universal life, a whole-life product, variable universal, etc. — you need to look at the company who backs it. You also need to analyze the past and expected performance and know how it fits in your overall strategy.

Each investor needs to know how these products and strategies will work if we have higher taxes, higher inflation and higher interest rates. The only thing we can be sure of is that the market conditions we see today will change. You need to develop strategies that will work no matter what conditions we have in the future.

Josh Cobb is a vice president with Peachtree Planning Corporation. Reach him at josh.cobb@peachtreeplanning.com or (404) 260-1642.