I did not make up this title (The Miracle of Cash Flow). A client said it to me earlier this year after we met to review the current state of their retirement plan. He expanded on what he meant by recalling that before he and his wife worked with me, they assumed that the only way to generate income from their investments was through interest from bank deposits and money market funds and dividends from stocks and bonds. With the assumption that income only comes from interest and dividends, they were living in a grim reality. In case you have not noticed, interest and dividend rates have been remarkably low for a long time. It has been hard to survive on interest and dividends alone in this low-rate world.
Cash flow is an important accounting distinction that addresses problems with liquidity. In personal terms, cash flow measures the movement of money in and out of your checking account. Just like a business, an individual or family can be financially profitable but still fail because they do not have cash. We all know people who complain that they are “house rich but cash poor”. The problem begins with the receipt of non-cash items that are counted as income even though they are not liquid.
Oprah Gives Away “Free” Cars
In 2004 on an episode of Oprah, the patron saint of generosity gave a brand new, “free” car to everyone in her audience. Under every seat in the auditorium was a set of keys to a brand new car. It was very dramatic to see the audience members screaming with joy as they ran through the parking structure to find their very own new car. A few days after the excitement subsided, the audience woke up to the fact that the new car was considered as non-cash income. Somehow, Oprah and her astute staff selected an audience of people who really needed a new, reliable car. What was also true was that this group was short on cash. Many of the recipients did not have the necessary cash on hand to pay the tax. This is a “cash flow” problem. They had three choices: pay the tax (approximately $7,000); sell the car, pay the tax and keep the after tax proceeds; or forfeit the car. Financially, it would have been better for Oprah to give each member of the audience a cash gift. If she had wanted to give everyone in the audience $20,000 net, she could have given them $25,000 so they would have $5,000 to pay the tax on what would be considered cash income by the IRS. Giving away the new cars made for much better television than gifts of cash; it was good advertising for General Motors; and in general, Oprah was recognized for her good intentions. Financially-savvy observers were mostly shocked that Oprah’s advisors or General Motors would not have anticipated this problem.
How to Generate Non-Traditional Cash Flow
Back to my client who inspired this topic: the important distinction about cash flow is that it always measures cash. Income measures cash and non-cash items, and you can’t pay tax or most expenses with non-cash items. Interest and dividends are the traditional sources of cash flow from retirement investments. In this low-interest and dividend rate environment, a non-traditional source of cash flow is the sale of investment shares in combination with interest and dividends. We call this a growth and income strategy. Working with balanced portfolios invested for both growth and income, we move strategically between fixed income investments (bond funds) and growth investments (stock funds). When cash flow is needed, we choose strategically whether it is better at each point in time to sell shares of the fixed income assets or the growth assets.
Cash Flow from the Taxable Account or the Retirement Account
Most investors have both tax-qualified retirement accounts [tax-deferred IRAs and 401(k)s] and taxable accounts from savings and investments outside retirement plans. By working with each client to understand their tax situation and their need for cash flow, we determine when to begin the retirement account withdrawals which are taxed as ordinary income. In some situations, cash flow can come from the taxable non-retirement accounts and be tax neutral. In most cases, it is best to defer the retirement withdrawals until the Required Minimum Distributions begin at age 70.5.
Another way we produce the miracle of cash flow is through a Social Security analysis for married couples approaching full retirement age. There is an often overlooked aspect of Social Security known as the Spousal Benefit. One spouse can claim a benefit from the other spouse while not diminishing each other’s direct benefits. It is a bit complicated so please give us a call and let us help you find money you may miss otherwise.