CASHFLOW OR INCOME..THE DIFFERENCE.

My 90+ Year Old Dad.  Working On His Finances.

Do You Really Have To  Know This?  My Dad did a great job based on his instincts and many people can.  I have to know more about how things work because I don't have sufficient instinct.  Whether or not you know how to manage by instinct, a knowledge of cash flow vs income can be valuable.  Many years ago, I helped people plan their retirement by making projections about how to collect sufficient assets and how much you can draw from those assets to assure that you have enough to last for your remaining life span.  In order to do this well, you need complex software and the ability to use it.  You also need to have the ability to explain it to your clients.  While it isn't all that difficult you also need to make certain assumptions as to the rate of inflation, the anticipated return on investment from the different categories and the projected lifespan of the potential retiree.  You might come up with an accurate projection but there is so much potential error in the assumptions that, no matter how good your software, an erroneous assumption can totally invalidate your projection.  I concluded that these were a waste of time.

Retirement is  All About Cash Flow.  It all boils down to a matter of replacing the cash flow you earn from work with cash flow from other sources.  It can also be about reducing your expenses.  A strict definition of cash flow is cash-in-minus cash-out.  You can manage your cash flow by increasing your income or by reducing your expense.  Either way, you are producing cash to fund your life.  Although cash flow can be equivalent to income and vice- versa, it isn't always. 

Cash Flow That Isn't Income.  Suppose you are refinancing your house and considering borrowing $100,000 at 3.75% for fifteen years.  Your payment will be $727. per month.  Instead you can get a 30-year loan at 4.25% for 30 years.  Your payment will be $492.  The 30-year loan improves your cash flow by $235 per month.  That extra $235 per month is yours to spend with no effect on your income for tax purposes.  Which is preferred?  Suppose you are 70 years old with little other retirement cash flow except for social security.  That extra 235 per month may make a huge difference in your life.  You will receive little benefit from the shorter-term loan until it's paid, at which time you are 85 years old.  Many of those I counsel need the cash flow now and not when they are nearing the end of their lifespan.  I am not saying that 30 year loans are better for everyone but choosing the short-term loan just because you are getting the benefit if 0.5% lower interest rate without considering the cash flow implications isn't always the best idea.

Income That Doesn't Produce Cash Flow.  Suppose I own a commercial rental property.  The rent is $4,000 per month and operating expenses are $1,000 per month.  I have a loan of 400,000 at 6% with 20 years remaining.  Payments on this loan are $2,865.  My cash flow is $4,000 minus $2,865 payments minus $1,000 operating expenses or $135 per month.  Because only the interest on this payment is deductible, my taxable income is  higher by $890 per month.  I have a tax obligation with no cash flow to pay it.  

Suppose I can't continue making the payments.  If this property goes into foreclosure, I am relieved of the monthly cash flow drain but I still might have income with no cash flow.  How can that be? 

Suppose I paid $300,000 for the property.  Since foreclosure is considered to be equivalent to a sale at the mortgage balance, I have a gain of $100,000 with no cash flow to pay it. 

This Post Is More Complex Than I Intended.  What I set out to do when making this post was to show  you some differences between income and cash flow.  In doing this, I have committed the biggest sin, b o o o r i n g.  On the other hand, if you slogged through this and came away with only the knowledge that you have to examine both the income and cash flow characteristics those financial decisions you make, I have accomplished my objective.  Perhaps I can make my next post more interesting.   I have written a booklet that discusses a number of financial issues facing those nearing retirement.  It is called "Fifty Tips For A Secure Retirement."  I wrote it almost 10 years ago, but 90% is still useful today.  Send me an e-mail at Pstorms@AOL.com with your address and I will mail you a copy.   

LET'S TAX THOSE EVIL RICH PEOPLE.

Nothing like a Gibson For The Blues.

Little Change From the 50's.  The democrats want the poor people to resent the rich.  I remember growing up in the Clear Creek Valley of Colorado.  Most of the people there were blue collar folks who called the republicans the party of the rich and the democrats the party of the "workin' man."  I am proud of my blue collar roots but not sure the democrats have ever totally represented my views. 

President Obama Exploits This Concept.  He continues to harp on the idea that the rich don't pay enough taxes.  He knows that no matter how high he raised the top bracket it won't help the deficit.  There simply aren't enough rich people to make a dent in it.  He's adopted this strategy because the average person resents the wealthy and how well they live.  What the less wealthy among us fail to recognize and Obama fails to tell us is that there is a huge difference between high income and wealth.  No matter how much he raises the top brackets, he won't be able to have much effect on the wealthy person who doesn't want to pay taxes.  

Look At This Example.  A citizen has just sold his business and has a net of fifty million after taxes.  He's tired of working and tired of having a high level of risk in his life.  He spreads this cash among several demand deposits in several banks.  These funds earn no income and he doesn't care.  He doesn't live cheaply, spending about a million dollars a year.  At the end of two years he has $48 million and has paid no taxes.  At this point he is tired of watching his nest egg decline and he invests 30 million in a portfolio of conservative growth stocks that pay no dividends but grow at the rate of 6% per year.  Since he still has no income, he still pays no taxes.  At the end of ten years, he has spent $10 million from his cash reserve and is down to eight million.  His stock portfolio has grown to almost $54 million.  He's lived very well, created more wealth than he started with and has paid no taxes.  All without finding exotic loopholes that no one else knows about.  If he wants to draw cash from that portfolio he might sell some stock and pay tax at the lower capital gains rate.  As an alternative, he can fund his expenses by borrowing from his portfolio and, although he has to pay interest, he will still owe no taxes and the interest paid will still be less than the tax he would have owed.  How does he get around the eventual tax bill on the growth in the stock he has accumulated?  He dies.  The heirs will inherit the stock at the fair market value at the time of death and there is no capital gains tax.  Estate taxes are another story and if you want to know how to get around those, we can save that for another post.  

What we need to emphasize here is that these aren't loopholes that are only open to rich folks.  They are part of the tax code available to everyone.  If your assets are less, divide by the difference.  If you have only $500,000 or 100 times less than 50 million, divide everything by 100.  You can have $10,000 per year to spend and pay no tax.  Of course, you can have more than this since only 53% of Americans pay tax any more.  A family of four with an income of $50,000 can take advantage of the tax code and pay no taxes. 

Are You Disappointed?  If you were anticipating some deep dark secret that allows the rich to avoid taxes, you may be disappointed.  My dear wife thinks I am wasting my time trying to explain the difference between high income and great wealth.  But its very important.  She says I should try to put together a short five word sound bite that explains what I mean.  I can't explain things in a five word sound bite but its important to remember that taxing the hell out of a high income taxpayer isn't as fair as you think.  I remember one year when everything fell into place and I had a $140,000 tax bill.  I also remember that I had years when I didn't make as much as my lowest paid employee.  Three years after that high tax year, I was struggling to keep the business going.  This is more the rule than the exception.  High income people seldom stay that way for long.  We are much better off with a tax code that encourages savings and investment than one where the government confiscates the money and spends it on wars, welfare, and entitlements.  

    

JANICE SIMONS.  A LIFE WELL LIVED.

Woke Up To Bad News.  I was sorry to find out this morning that my cousin, Janice Simons had died.  Its not that we were very close all these years.  I still remember her as my sweet little cousin, born a few months after my brother.  Being older by seven years, I never paid much attention to her.  She was my Uncle Norman's youngest daughter.

Uncle Norman Was The Oldest Sibling.   Uncle Norman was one of three boys born to my granddad, Hardy Storms.  He was also the least healthy.  They called it "leakage of the heart" in those days and he only lasted until age 37.  He died leaving a wife and three children.  All broken hearted. There were barely enough funds to bury him.  My Aunt Lois, was left with a small, almost broken down house and no income except for social security payments.  I would like to say that the rest of the family jumped in to help but the truth is, none of the rest had more more than enough for a minimal standard of living.  Aunt Lois didn't complain.  She took in ironing for years, raised her children well, and was active in her church.  She was well past 80 when she died.

My Sweet Little Cousin Started High School.  At least, I think she did but I'm pretty sure she didn't finish.  One of her neighbors, Dick Simons took an interest in her when she was around 14 years of age.  Dick wasn't much older, just a couple of years.  He was from a family just a small distance away.  They married when they were teenagers.  None of us expected much from them.  That was our first mistake.  Dick turned out to be a hard worker and a loyal employee of the Coors company in Golden.  He and Jan were married for more than 50 years.  They raised their family well and, although I didn't spend much time with them, I was really proud of the way they pulled together and did what they had to do raise a strong family.  

Uncle Norman's Heart Problem Passed to The Kids.  The oldest, Doris died somewhere around the age of 60.  The next, Duane didn't make it very much past that.  Janice was almost 68.  No one expected her heart to last this long.  I must admit it, I feel guilty that I never spent much time with any of them.  I guess it doesn't really matter a lot because they had ample friends and family.  My sweet little cousin was able to spend her last few days at home, surrounded by those who loved her very much.  I guess none of us can ask for more than that.