“Everyone needs to have a financial planner.”
I have seen many financial advisors say this and I don’t agree. There are plenty of people out there who can mostly DIY.
Whether this is because their situation is simple or because they are very financially savvy, I think DIYing can be a great route. However, many people who should not be DIYing are… And this has led to some HUGE mistakes.
In this blog post, I am going to share 6 huge mistakes people have made when handling their finances themselves.
Someone I have worked with was lucky enough to receive a nice inheritance. They received about $500,000 in an investment account, but what they did not understand was that this was from a pre-tax retirement account. Because of when the parent passed away, the plan rules stated they had to have the funds out within 5 years. They did not know this at all. If they were working with a planner, they could have taken these funds out equally over 5 years (roughly $100k a year) and been taxed at the 24% bracket. They also could have increased their pre-tax contributions to offset this tax by a decent amount.
Instead… they had no idea.
They took $0 out over the 5 years and did not notice this until about 3 years after it should have been withdrawn.
This led to not only a large amount of penalties, but then they had to withdraw all this out in 1 year .This pushed them into the highest tax bracket they had ever been in - filling up 24%, 32% and some of 35% bracket. They paid way more in taxes than they needed to had they just planned well.
Roth conversions are one of the most powerful tools in reducing effective lifetime taxes. They allow you to defer tax in high income earning years, then pay tax and convert in low income years, thus lowering your effective lifetime rate.
The problem… this person heard about Roth conversions and the impact and decided it was time to do them. They were in their early 50’s and in the highest bracket they had every been in. They were mostly deferring at 24% and 32% but now are in 35% this year.
They decided to convert (which I would not have recommended with them being in their highest bracket ever) but this is not the big mistake. They converted through 35% and some at 37%, but they also withheld from the account for the tax liability.
YOU CANNOT DO THIS.
Since he was not over 59.5, withholding for taxes from the distribution itself leads to a 10% penalty. This did not end as well as he had hoped.
Someone I work with was told that an S Corp was the right move for them to make. They were doing well and wanted to save on taxes, so with the guidance of a friend, he set up this S Corp and started paying himself a $50k salary so he could save on self employment taxes.
But the profit of the business was $600k. We will ignore the fact that this salary is not reasonable (at all).
So yes… he saved on self employment taxes. He only had to pay 15.3% x $50k = $7,650 in payroll taxes, but… he now only got a $25k QBI deduction (50% of W2 wages).
If he had optimized this better, he would have had an $185k salary which would have led to a $92,500 deduction.
The QBI deduction would be either 20% of business profits or 50% of W2 wages, whichever is lesser. This change would lead to him getting $92,500 deduction vs $25,000. $67,500 more.
Additionally, it would allow him to get significantly more into a solo 401(k). He was leaving $50k in tax savings on the table by listening to someone who really does not understand real tax planning.
This family owned a solo business. The wife had built something really cool and the husband was helping do a lot of the work, but they were only paying the wife and had no retirement accounts setup. They were in the 35% bracket and one of the highest state tax states and hoping to reduce their tax burden. Their strategy was to just get paid, pay taxes, and invest in a taxable account. Not a terrible strategy.
But, they were missing out on using a solo 401(k) and either deferring a ton in taxes or going all Roth and never paying tax again (better than paying capital gains). They could have hired the husband for all the financial work he was doing, pay him a fair amount (20 hours a week) so about $30k and get both of them on a solo 401(k). They could do $66,000 last year for the wife, and then do roughly $30,000 for him. This would $99,000 either pre-tax and saving them nearly $40k in taxes. Or do all Roth and let nearly 6 figures grow tax free for a long time. Talk about a missed opportunity the past 5 years.
This family had been over the income limit for Roth IRAs for quite some time. They had no idea there even was an income limit, so for at least the past decade, they were doing Roth contributions even though they were not allowed to. They also had money in an IRA so it was not easy to quickly get this money out and reverse it. If you have money in a Roth IRA when you are not supposed to you pay a 6% penalty for the excess amount. They were filing their own taxes and had no idea. Now they have large penalties for all the years this has been in there (not fun).
Someone reached out to me on X (then Twitter) saying they had started a business and did not know anything about 83(b) elections so they never filed one. The business started at a value of about $0 and they could have filed and pre-paid taxes at nearly $0.
Instead, their shares have vested and the company is now valued at about $25mil. They now owe taxes in this year based on that valuation. They have no idea if this company is going to be sellable, they are not being paid much, yet they owe tax on nearly $5mil of equity vesting. This is a huge mistake.
A million dollar mistake that could have been avoided if they had the right team in place.
I see this happen all the time with new founders. Do not let this be you.
I write this, not to scare you or force you into working with an advisor. Many people can DIY, but there are times in life where consulting with a professional will really pay off. And if you are not taking good care of your finances, hire someone. This is an investment into making sure you do the right things. Not just a cost.
Financial Advisor