Cash flow important to financial planning

January 23, 2015

Cardiovascular is a big name for one of the most important systems in the body. Made up of the heart, blood and blood vessels, the circulatory system is your body’s delivery system. Blood moving from the heart, delivers oxygen and nutrients to every part of the body. On the return trip, the blood picks up waste products so that your body can get rid of them.

Interestingly, the name is kind of backwards when it comes to problems within the system. Most “heart attacks” are not caused by the heart (cardio); instead, they are caused by blockages in the arteries (vascular). So, the medical profession may want to rename the system –Vascularcardio.

Wait a minute. I thought this was a financial column. Actually, it is. I just wanted to compare the system that delivers the lifeblood to the human body to cash flow in financial planning. It is that important.

OK, what is cash flow? It’s pretty simple. Step number one – add up your income: salary, bonus, rents, royalties, dividends, etc. Step number two – subtract from that your expenses: rent, mortgage, food, shelter, clothing, 401(k) deferrals, etc. Step number three – estimate your taxes: you can get payroll taxes from your pay stub; you can estimate state and federal taxes from last year’s returns. Step number four – subtract expenses and taxes from income, and voilà, you’re done.

What now? Well, if you have a positive cash flow, you can plan how to best invest it. If your primary goal is retirement, the best place to invest your cash flow is in a qualified retirement plan such as a 401(k), IRA, etc. When you put money into a qualified plan you get an income tax deduction in the amount of your contribution. This is good because it doesn’t cost you a dollar to invest a dollar. If you are in the 25 percent tax bracket, it only costs 75 cents to invest a dollar.

As long as you leave the money inside the plan, it grows tax-deferred. This too is good because you don’t have to share the compound growth with the government every year. Eventually, if you’re like most people, when you withdraw money from the plan, you will be in a lower tax bracket, so let’s put a triple on the scoreboard. Of course, if you have other goals, like educating your children, then you would use other tax advantaged vehicles such as Section 529 Plans to fund those goals.

Putting money into investments is fine but the name of the game is to reach your goals. Just how much money do you need to put in to your retirement plan to achieve a successful retirement? How much money do you need to put into the 529 plans or other college savings vehicles to educate your children or grandchildren?

This is a bit much to ask of your fingers and toes, or even a fancy calculator. This job requires a computer program that can calculate numerous variables including rates of return, inflation, market volatility, etc.

Once again, we’re back to cash flow. How much will you need, and when, to educate your children, take care of your parents, if necessary, whatever else, and retire. You need to prepare future cash flows to calculate how much you will need to achieve your goals.

Recently, I was reviewing a financial plan with a couple and the husband voiced concern saying, “Do you mean that I have to have X dollars in my account before I can retire?” He was looking at the gross needed at retirement. My answer was, “No, because you forgot to factor in your expected annual Social Security benefits of $40,000-plus that greatly reduce the amount needed to fund your retirement.”

Prior to investing in a 529 Plan investors should consider whether the investor’s or designated beneficiary’s home state offers any state tax or other benefits that are only available for investments in such state’s qualified tuition program. Withdrawals used for qualified expenses are federally tax free. Tax treatment at the state level may vary. Please consult with your tax advisor before investing.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for the individual. Randy Neumann, CFP® is a registered representative with and securities offered through LPL Financial. Member FINRA/SIPC. He can be reached at 600 East Crescent Avenue, Suite 104, Upper Saddle River, NJ 07458, 201-291-9000.