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Income Or Cash Flow- How Do You Get Paid?

When or if you are or were working as an employee- or drawing income from a self-employed business every two weeks like clockwork, you received your paycheck. Taxes were taken out, and hopefully, so was your retirement contribution. You counted on it, budgeted for it, and knew it was there on time to pay your bills. It was (hopefully) a constant, and as long as you went to work, you got paid. Nary was a thought given to paying your taxes on your own as it was automatically deducted and sent in for you, and only at tax time did you give it any attention- mostly hoping you were due for a refund. The key point is that the paycheck you received to keep you afloat monthly had nothing to do with your savings or investments for the most part- you were supported from your weekly or monthly income earned from wages. Now that you’re retired or not earning wages from working- and the whole ballgame has changed.

While some of your income may remain a constant as in Social Security income or pension checks, once you stop working, depending on how you receive your new non-wage income, it now can or may be classified as cash flow as opposed to income. Why you ask? Because the definition of income for the most part usually changes once you stop working from income to cash flow. While income is defined above, most income is reclassified as cash flow because of the way it comes to you. It may be in the form of interest, dividends, and capital gains: it’s different as it is dependent on your type and classification of investment generating the income. If your “income” is from an immediate annuity with a lifetime payout, the income is classified partly as income and partly return of principal. In a Master Limited Partnership, what looks like “tax sheltering” is actually because your income is partly return of principal. This article is by no means meant to be giving tax advice: only that can be obtained from your trusted tax advisor. The purpose it to discuss how money comes to you in retirement, and how it is classified. Confusion occurs when a person thinks the check coming to them is income, when in fact it may contain a part of your principal. One day when you least expect it, you may find that your principal is all gone, and so are your monthly payments. Knowledge is power, and I cannot express to you more how important it is to speak with your tax advisor or Certified Financial Planner™ professional to make sure this doesn’t happen to you someday, when your working years are far behind you.

Durable income is defined as income you cannot outlive. Based on mortality tables, people are living much longer these days. Diversification and a portfolio tailored specifically for your specific situation is therefore so important to include suitability, tax ramifications, liquidity needs, and well within your risk tolerance.  Working with a financial professional is so important at this stage of your life, but it important to remember that it is your money, and whether you choose to spend principal is entirely up to you- as long as you understand the ramifications. Dying and leaving a lot of money means simply how much you’ll leave to your kids. The question is how much are you willing to sacrifice when living in your golden years to leave it to them? If your income is a combination of income and principal, little by little, will you will dissipate your principal? How long will it last until you run out of money entirely? If you are careful and are on top of your investments, gauge how much principal you use annually and make sure it’s enough to be “durable” you should have enough to last your lifetime- this would be classified as “cash flow-“ using income, dividends and some of your principal all at the same time. While using principle is usually classified as a no-no, at some time in your life you may find the need… be careful- the one thing we don’t know is when our time is up. If you spend your principal, you may find yourself outliving your money- not a desirable occurrence. In the case of IRA’s or other before tax, qualified plans, it gets a bit more confusing: once you reach the age of 70 ½ and you have to start taking out due to the Required Minimum Distribution rules, you are taking out principal, but for tax purposes it’s defined and taxed as income.  The main reason for this article is to make you aware that the check that comes to you each month may change in the eyes of the IRS- and you may find yourself in a tax bind you never encountered before. Income planning takes time- it doesn’t just happen. If you know in advance that you will need cash flow as opposed to income, the best time to plan is the earliest you can. Be sure to confer with your trusted advisors. Don’t wait until it’s the 12th hour- waiting may be hazardous to your wealth!

To all my readers: I wish you all a wonderful holiday season, filled with health, family and most of all…lots of fun, fun, fun

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