Tag Archives: decision making

Rethinking Investing and Paying off Debts

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the best path may have changed ….

Investing has changed as times have changed … financial planning rules need to change too

Old thinking

In the past, when asked by a client about adding principal payments to reduce mortgage debt, so that the mortgage would be paid off sooner, I advised them to invest that payment instead.  

That advice was based on the financial planning rule that you do not pay off debt when the after-tax cost of the debt is less than the after-tax return on the investments.  Instead, you use cash flow to add to the investment because this is how you increase your net worth – the total of all investments less all debt – over time. 

Also, by not paying down your mortgage quickly, you had the added benefit of not tying up working capital in your home.  You cannot sell a bedroom when you need funds for a child going to college. 

But that was then … things are different now ….

Changes

All components of the financial planning rule need to be reevaluated:  Interest rates and inflation are at or near historic lows.  The tax law on deduction of mortgage and other interest on debts has changed.  The disruption to the economy from the Pandemic has hurt businesses and that will affect future investment returns. 

Interest rates – With interest rates so low, the investment return on cash is near zero and the return on bonds is very low.  Rates are almost certain to rise, which will make bonds today worth less in the future (when low interest bonds compete against newer bonds that offer higher interest rates, they are re-priced to match the new rate and that decreases what anyone will pay for the old bonds). 

Tax deductions – The Tax Cut and Jobs Act made the standard deduction the option for more than two-thirds of taxpayers.  With the standard deduction, there is no benefit because the mortgage interest is not actually deducted to lower your net taxes due.  That means that the after-tax cost of mortgage debt is no better than the before-tax cost. 

Investment returns – to get a better sense of the likely investment returns for that side of the rule, I spoke to Hal Hallstein IV of the Sankala Group, LLC out of Boulder, CO.  He referred me to their post on Money Supply & Discount Rates, in which they discuss the impact of stimulus checks and PPP loans in an economy where recipients are likely to invest those funds or make financial purchases because simple consumption, travel and entertainment, has been shut down.  They also discuss the threshold return required for making an investment decision, viz. the discount rate.  In the post, he states:

But simultaneously, we also know buying bonds with zero yields won’t work for people’s retirements, which realistically require 3% yields. Where does this leave us?

He then presents a rationale for owning gold, an asset he has always avoided, as have I.  But now it serves as a protection against a downturn when you have a portfolio that invests primarily in the stock market. 

In our conversation, we compared the weighted cost of capital, the blended rate on all your debt, against the expected return from investing, which he pegs at 3.5 to 4.25% over the next decade, due to high equity valuations in the US and low interest rates.* 

One note of caution: to get those returns will require tolerating substantial volatility.

All of this leads to the following:  if your mortgage is at 3.5%, and you get no deduction value, and your potential return is 3.5% before taxes, on which you will have some tax hit, now or later, then paying off the debt is a better choice financially than adding to your investments.

New planning ideas

When you apply the debt to investment rule above, more people may find it best to pay down debt. 

For a mortgage, added to your monthly payment will have a substantial impact over time, cutting the total interest paid.  If you have a Roth IRA, it may even make sense to distribute funds to pay a student loan or car loan, depending on the loan interest rate.

There are still some reasons not to switch from retirement investing to debt reduction, such as when your employer offers a match for contributions.  For a good set of considerations to review before acting, see the Betterment 5-Step Action Plan.

Conclusion

While the planning rule used to lead to the conclusion that you are best off adding to investments rather than accelerating paying off long-term debt like a mortgage or car loan, the conclusion from applying that rule has flipped.  Many will increase their net worth by paying down debt sooner. 

I hope you and your loved ones are all managing this as well as you can during the Pandemic. 

Thank you, and be well

Steven

  * Sankala Group LLC’s communications should not be considered by any client or prospective client as a solicitation or recommendation to affect any transactions in securities. Any direct communication by Sankala Group LLC with a client or prospective client will be carried out by a representative that is either registered with or qualifies for an exemption or exclusion from registration in the state where the prospective client resides. Sankala Group LLC does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information presented in this communication, or by any unaffiliated third party. All such information is provided solely for illustrative purposes.

Steven A. Branson, retirement, investing, Financial Strategies, debt, discount rate, decision making, newsletter, cost of capital

CARES Act, Stimulus checks, and other tax law updates

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Keeping in touch during these challenging times …

2019 due dates (tax season is not quite over yet)

The IRS extended all of the following deadlines to July 15th:

  • 2019 return or extension filing;
  • Payment of 2019 taxes due;
  • Q1 2020 estimate payment; and
  • Q2 2020 estimate payment.

Most states have followed the same delayed dates (but not all).  Let me know if you have a question on payment and filing. 

So “tax season” will be over soon, yea!

Stimulus checks and other changes

Many people are asking about their stimulus checks and expanded unemployment benefits under the Coronavirus Aid, Relief, and Economic Security (CARES) Act.  The Act also has other provisions including tax credits for self-employed affected by Covid-19, student loan payment delays, and relief on mortgage payments and rent.

Of the many posts regarding the stimulus checks and benefits, student loans and 401(k) distributions, here is a good summary from the NY Times. 

If you want to check on the status of your stimulus check, here is the IRS website to find the status or apply for your stimulus check.  If you expect a check that has not arrived, check out the links in this Huffington Post article. 

And if you received a check for a deceased relative (over 1 million were sent!), you need to return it to the Treasury, sorry. 

Small businesses

CARES Act includes benefits for small businesses: Payroll Protection Program loans; payroll deposit delays; and tax credits.  The SBA funds for the PPP ran out initially, but Congress added more funding. 

The key is to file so that the loan is forgiven, so that the funds become a grant.  The forgiven loan is not treated as income.  

If you need more information on these programs, let me know. 

2020 tax law changes

The required minimum distributions or RMDs are suspended for 2020.  This way, you do not need to sell funds at a low to withdraw and may even be able to redeposit funds that you already withdrew. 

The CARES Act waives the 10% penalty for early withdrawals from qualified plans for up to $100,000 for coronavirus-related circumstances. The distribution is taxed over three years. And, if the funds withdrawn are repaid to the plan within 3 years, that is treated as a tax-free roll over.  The act also allows loan from the plan up to the lesser of the vested balance and $100,000. 

For 2020, there is an above-the-line charitable donation deduction up to $300.  This should help charities that are responding to those impacted helping them raise money now.

More Scams and Hackers

Be wary of messages asking for personal information because scams are on the rise.  And be careful working from home, as there are more hacker attempts to gain access via the home connections to companies. 

If you want help dealing with any, let me know.

Personal impact

Being cooped up is challenging, even if it is the best way to stay healthy.  Make sure you practice self-care so you can handle this! 

I hope you and your loved ones are all managing this as well as you can.

If you want to just talk, I would be glad to set up a time, just let me know! 

Thank you, and be well

Steven

Year-end tax planning – 2019 update on using the tax laws to save you money

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we hope your planning does not look like this!

Last year, we provided a three-part series explaining the impact of the new tax law.  In our first part, we discussed the impact of the new law on personal taxes and in our second part, we discussed planning for small businesses.  In this part, we update the third part posted last year, which is our guide for year-end moves to reduce total taxes between 2019 and 2020. 

Can you act at all?   

Each year we advise that you be practical, focusing on where you can actually take action. 

For many, the new $24,000 standard deduction for married couples, $12,000 for single taxpayers, means you will not itemize (i.e., your total for itemized deductions is less than the standard amount so you take the higher, standard deduction).  The standard deduction goes up when you reach 65. 

If you are not itemizing, you have fewer ways in which to affect change in the taxes due in either year (but you can also stop collecting receipts for those deductions!). 

Some possible deduction strategies

One technique for getting around the limit is to bunch deductions from two or more years into one year.  The one deduction that you can easily move is for charitable donations.  Your state, local and real estate taxes are limited to a $10,000 maximum and you cannot accelerate, or delay, significant amounts of mortgage interest. 

If you do not want any one charity to receive the full amount in a single year, you can still use this bunching strategy.  Donate to a donor advised fund, from which you may be able to designate donations to particular charities in future years.

IRA donations:  If you are 70½ or older, you have the option of distributing up to $100,000 from your IRA or other qualified plan to an IRS-approved charity and having none of the distribution taxed. 

Capital Gains:  Review your portfolio.  You may be able to “harvest losses” to offset capital gains realized on stock sales or mutual fund capital gains distributions.  If you have substantial unrealized gains, consider donating to a charity.  See below. 

The tax planning steps

If you are able to itemize, determine what income and deductions you can move from 2019 to 2020 or vice versa.  You want to minimize total taxes for both years.  Make sure your planning includes the 3.8% Medicare tax on high income and review Roth conversions (Roth distributions are not taxed, so converting a traditional or roll-over IRA to a Roth could be beneficial, as long as the tax cost now is not too great).  And business owners will want to review our post on planning under 199A for QBID. 

Next, review the impact of moving income and expense to see what happens if you shift any of these amounts from one year to the other year.

But, watch for the Alternative Minimum Tax (“AMT”):

  • The exemption for the AMT and the threshold above which that exemption gets phased out are now higher than before 2018, so fewer taxpayers will owe the AMT.  

Finally, if you have not maxed-out your 401(k) plan, IRA, Health Savings Account or flex plan account, consider doing so before the end of the year.

Capital gains

Your mutual funds may have large capital gains distributions.  Christine Benz says, “Brace yourself: 2019 is apt to be another not-so-happy capital gains distribution season, with many growth-oriented mutual funds dishing out sizable payouts.”  

Review your unrealized losses to see if you can “harvest” those losses to offset or “shelter” realized gains, reducing your total taxable income.  If you have more losses than gains, you can take up to $3,000 of capital losses against other income. 

If you sell an asset that you would prefer to retain, in order to shelter gains in 2019, make sure you do not run afoul of the wash-sale rule (any loss on an asset that you repurchase in 30 days will be disallowed, so you have to either wait 30 days or purchase a similar asset that fits your asset allocation while not counting against the wash sale rule). 

If you have significant unrealized gains, consider using appreciated stock for charitable donations – that way you avoid the tax on the gain while still getting the full fair market value for your charitable donation.  

Some reminders on itemized deductions

As you may recall, mortgage interest on new home purchases is deductible only for loans of up to $750,000 used to purchase or improve your primary or secondary residence.  Interest on home equity loans will not be deductible, except when the home equity indebtedness is used to purchase or improve the residence.

Also, all miscellaneous deductions were eliminated.  This includes investment and tax preparation fees, safe deposit box charges and unreimbursed employee business expenses.  And moving expenses are no longer allowed (except for military personnel in certain cases). 

Check taxes paid

Make sure your total paid in withholdings and estimates meets the safe harbor rules.  If not, you could owe interest for under-withholding. 

Estate plan review

While you review your taxes, consider reviewing your estate plan and your beneficiary designations.  The federal exemption is just over $11 million in 2019, so fewer people will owe any federal estate tax.  However, many states still impose estate taxes on smaller estates.  If you have “excess wealth” and want to reduce your taxable estate by gifting assets to children or others, you can give $15,000 per person, per year.  If your spouse joins you, that is $30,000 per person.  This includes funding a 529 plan for education costs – expanded to provide for more than just college. 

Note, however, that holding appreciated assets for the step up in basis at death may be better for your heirs than gifting. 

Check on 2018

Check to see if you over-paid a penalty for under-withholding.  If you filed early, the penalty calculation may have over-stated the total you owe, so you will want to review your 2018 filing. 

Summary

Carefully review any income and deductions that you can still shift to see if moving will lessen the total taxes you pay for 2019 and 2020. 

Good luck and best wishes for the holidays!

Will you leave a mess or a legacy? Don’t die without a plan

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“where did they leave it?”

Estate planning is not fun.  You have to face what the world will be like after you leave it.  You want to leave a legacy so your survivors are happy.  However, less than one in five of you have taken the steps needed. 

If you completely ignore creating a post-death plan, then you will leave a chaos and confusion for others to sort out at a time when they will be grieving from your loss.  They will have to find where you put everything and sort out where you wanted everything to go. 

If people depend on you financially, not providing enough on which they can survive will mean major lifestyle changes for them.  Not something you want. 

You want survivors to focus on cherished memories, not on probate courts.  Take action! 

Now, what do you do?

First, leave enough so survivors can survive

Make sure you have provided for those who depend on you.  Usually, that means purchasing some form of life insurance.  You want to replace your earning power from now until the time that they are independent, either when a spouse or partner retires or when your children become gainfully employed. 

If you have been saving for retirement, those accounts may be enough so you don’t need to purchase life insurance.  Reviewing your potential estate with an advisor is wise to make sure survivors have enough. 

Second, sign the documents

Execute documents that ensure that your estate goes to the people who you want to benefit.  This usually means signing beneficiary designations for retirement plan accounts and executing a will.  You may even need a trust for young survivors.  We wrote this post detailing the steps a few years back.  If that’s too technical, ask me questions. 

You may want to consult an advisor to get all the proper documents in place.  Here is a good checklist to review.

Third, have the conversations

Talk to your spouse, to your adult children and to the people you name in your documents.  Make sure they understand your wishes.  Do you want to be buried or do you want to be cremated?  Do you want donations made to charities? 

What if you have a catastrophe the doesn’t kill you, but leaves you hooked up to machines forever?  Have a conversation so your loved ones know your wishes.  And, make sure you sign a health care proxy or medical directive, living will and even a “do not resuscitate” or DNR order. 

Fourth, leave a trail

Make sure the key people know how to find everything.  One way is to write a memorandum listing your passwords, where to find the safe deposit box key, and where you stored the life insurance policies.  Give copes to key people, such as the personal representative named in you will or the trustee of your trust. 

Finally, leave a legacy

When you take care of all you can, in advance, your survivors don’t have to suppress feelings while they clean up a mess:

“WE WERE WORRIED ABOUT MY MOM after my dad died, but he had everything in order. It allowed us to focus on our grief instead of being bogged down in financial paperwork and family bickering.” That’s one of the candid responses Merrill Lynch and Age Wave received when they interviewed more than 3,000 Americans 55 and older for a comprehensive look at attitudes and practices surrounding legacy planning.  From How do you want to be remembered…

planning and taking action

You will need to review and update your plan over time.  But, just knowing you took all these steps should improve matters for you and your family now!  Contact our office if you have questions so you can “don’t worry, be happy!”

Do you need to amend for tax extenders, SALT workarounds, state tax domicile and empowerment zone gains?

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This tax update may give you reasons to amend your tax returns regarding the tax extenders, SALT workarounds, domicile audits and empowerment zones. Let me know if you need help.

Tax Deduction Superhero?

Tax extenders

Many tax returns were prepared assuming that Congress would pass a law for the “tax extenders” as it has in past years. However, the bill extending deductions and credits for 2018 and 2019 has not passed. Other matters have the attention of Congress.

The tax extenders include 26 tax breaks that expired at the end of 2017 and 2018. Some are for businesses, such as motor speedway depreciation, biodiesel credits, and disaster relief. Others are for individuals, such as retaining the 7.5% threshold instead of 10% for medical expenses, the private mortgage insurance (PMI) deduction, exclusion of up to $2 million from income from mortgage debt forgiveness on your home, and an above-the-line deduction college tuition and qualified expenses.

If you filed your 2018 returns relying on passage, and the extender bill does not pass, you could face an inquiry form the IRS. If you filed without relying on the extenders, and the bill does pass, you may be able to amend your 2018 filing to obtain a refund.

SALT and work around attempts by states

As you know from the first post in our series on the Tax Cut and Job Act (“TCJA”), the new tax law places a $10,000 cap on state and local taxes, or “SALT.” This includes state and city income taxes, property taxes, sales taxes and excise taxes.

Some states, including New York and New Jersey, felt that TCJA targeted them and responded with workarounds. One such measure provides that certain payments of state income taxes would be treated as charitable contributions, so that the full amount would be allowed as part of your Schedule A deductions.

The IRS reacted by indicating that only the IRS determines what are allowable Schedule A deductions and this workaround was not one of them. As Christy Rakoczy Bieber wrote recently on creditkarma.com:

If you’re counting on a SALT cap workaround from your state to keep your federal taxes low, you may face an unpleasant surprise at tax time since the IRS has made clear it won’t allow you to take deductions for charitable donations if you received tax credits.

Trying to avoid the state taxes

Some people with homes in more than one state have taken another approach to SALT limits by claiming to be residents of the state imposing less income taxes. For example, if you have homes in Massachusetts and in Florida, you would clearly pick Florida because there is no state income tax.

If you do pick a no or low-income tax state, be careful. The state that is missing out on tax revenue may conduct a domicile audit. Having the documentation to prove your residency is key. While residency is based on your “state of mind,” an audit would focus on a list of facts, including where you spend more time, the state in which you have a driver’s license and vote, where you receive your mail, and where you worship. Be sure to take the necessary steps and retain proof.

Empowerment Zone rollovers and Qualified Small Business Stock Sales (QSBS)

There are provisions for favorable treatment of certain capital gains transactions. Here are two:

  • If you purchased stock in a qualified small business, you may be able to exclude gain on the sale. The exclusion is even higher for certain empowerment zones, and;
  • You can roll over gain from certain sales into investments in an empowerment zone, delaying or even reducing the tax on the gain. There are opportunity funds into which you can invest for this deferral. If you think you need to amend, or if you have any questions on this post or any other matter, let me know. I am here to help.
thinking about a refund?

If you think you need to amend, or if you have any questions on this post or any other matter, let me know. I am here to help.