Top Three Reasons Not To Trust a Balance Sheet

Often, most of us think we’ve got our balance sheets in order. For instance, you might know how much you owe on your car, mortgage, and other debts. Others may know how much they have in retirement assets, house equity, and in retirement savings.

However, if you hold any retirement savings in a 401(k) and an IRA, you should consider the effect of taxes on your cash value. Additionally, you need to factor in the impact of fluctuating stock indexes on your income.

In February, the stock market tanked with over 1,000 points, then recovered. Though analysts consider this a 10% correction, it may point to possible volatility. At present, it is impossible knowing what the future holds. But February’s revision prompted concern over IRA and 401(k) statements among Americans. For a majority of Americans, it is difficult telling the difference between paper wealth and actual wealth. What’s worse, this difference can have a significant impact on your net worth.

Ideally, you should maintain an annual balance sheet that tracks your progress towards financial goals. With it, you’ll have a picture of what you own and what you owe. An annual balance sheet can help you better understand your financial position. For instance, if you have debts that are greater than your income, then your net worth is negative. If so, then you could be staring at financial insolvency and possibly bankruptcy.

Luckily, there are many personal financial planning software applications for use in developing your balance sheet. Even so, keep it in mind that a balance sheet doesn’t always reflect your whole picture. A balance sheet can mislead when estimating your net worth.  Given that, let’s consider the factors that can affect your bottom line.

Benefits of TSP

Factor # 1: Hidden Taxes

Assume you have $300,000 in an IRA, a 401(k), or a traditional savings account (not a Roth IRA). Typically, these accounts are considered as $300,000 in assets with considerable tax liabilities. Every dollar withdrawn from a traditional retirement account is taxable. Using the above figure if you are in the 25% tax bracket, your tax equates to $75,000.

Factor # 2: Your Estate’s Value

All funds in a traditional retirement account go to your beneficiaries upon your demise. However, your heirs will have to clear any income taxes you owe. Additionally, they may have to pay estate tax on any retirement money they inherit.

Factor # 3: Adjusted Retirement Account Values

A balance sheet is just an estimate of the assets net worth of your assets at the present market rates. On the contrary, it doesn’t portray what you might be worth if the market collapses or rises. Since 2000, the market has dropped twice by more than 50%. This is why you need to factor this percentage when preparing a balance sheet. On the other hand, assume you had $300,000 in a dividend paying life insurance policy.  In this case, you could leverage a legal provision that allows for cash withdrawals that have no tax obligations. You get to keep your entire $300,000 asset.

In case you die before depleting saving in a traditional retirement account, your family pays any owed income taxes on the sum they inherit. Under current law, a life insurance policy pays the entire value of your death benefit to your family without any income tax deductions.

Therefore, you should consider the impact of income taxes, market volatility, and estate value when preparing a balance sheet in the future. Doing so will help you create a saving strategy to meet your unique needs.

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