Markets Soared in 2017

Posted On December 30, 2017 By Scott Stratton, CFP(R), CFA In Portfolio Management /  

2017 was an outstanding year for investors. Markets went up throughout the year with little volatility and no significant pull-backs. This certainly has been a pleasant surprise, given the political uncertainty, noise, and dysfunction in Washington. Here’s a quick overview of the performance of major indices this past year.

The S&P 500 Index was up 21.83%, in total return. US stocks were already fairly valued at the start of the year, but investor enthusiasm for technology companies has pushed markets even higher. That means we start 2018 at even higher valuations than those which concerned us a year ago.

I’d also note that growth stocks outperformed value strategies, by nearly 2X in 2017. I think this will reverse at some point as value stocks have a widening discount to growth companies. US Large Cap outperformed Small Cap by a wide margin, reflecting the more expensive valuations of small companies.

Look at international markets, the MSCI EAFE index, representing developed economies outside the US, was up 25.03%. The MSCI Emerging Markets Index soared 34.35% on the year. Both of these were boosted by a sagging dollar in 2017. We don’t make active bets on currency direction, so we don’t have an opinion on whether or not this continues to enhance returns in 2018. However, economic growth and stock fundamentals are both favorable for international stocks in the year ahead.

Turning to bonds, the Barclay’s Aggregate Bond Index was up 3.54%, a decent return for a year in which the Federal Reserve raised rates three times. We believe that bond investors should have modest expectations for 2018. Rising rates suggest favoring shorter duration bonds for defense.

We’ve updated our portfolio models for 2018 and can celebrate the returns we received in 2017. We remain broadly diversified and get most of our equity exposure from low-cost, tax-efficient index ETFs. Our overweight to Emerging Markets has been beneficial this past year, although our allocation to US Value has been a drag on performance. The rationale for both positions remains unchanged so we will continue to hold both.

We spend considerable time on investment management, but generally, think it is more beneficial to you to write here about financial planning topics. As always, if you have any questions about investment strategies, please feel free to reply or call anytime.

Source of data: Morningstar as of 12/30/2017. 

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Charitable Giving Under The New Tax Law

Posted On December 21, 2017 By Scott Stratton, CFP(R), CFA In Tax Strategies /   2 Comments

Starting in 2018, it is going to be much more difficult to deduct your Charitable Donations. That’s because the standard deduction will rise from $6,350 (single) and $12,700 (married) in 2017 to $12,000 and $24,000 in 2018. You will need to exceed this much higher threshold to deduct your charitable gifts.

It will be even more difficult to reach those levels because the Tax Cuts and Jobs Act (TCJA) is also capping your state and local taxes (property, income, and sales) to $10,000. And they completely eliminated your ability to deduct “miscellaneous” expenses including unreimbursed employee expenses, home office expenses, tax preparation, and investment advisory fees.

Let’s take a look at a hypothetical scenario for a married couple:

In 2017, a typical year, let’s say you have $12,000 in local taxes, $4,000 in mortgage interest, $10,000 in charitable donations, $5,000 in unreimbursed employee expenses, and $6,000 in investment and tax preparation fees. (Let’s assume these miscellaneous amounts are the amounts above the 2% of AGI threshold.) Your total itemized tax deduction would be $37,000 for 2017. That’s well above the standard deduction of $12,700.

In 2018, you spend exactly the same amounts. However, under the TCJA, your local tax deduction is capped at $10,000. You keep the mortgage interest deduction of $4,000 and the $10,000 in charitable donations. The $5,000 in unreimbursed employee expenses and the $6,000 in investment and tax preparation fees are both disregarded. Your new tax deduction would be $24,000.

$24,000 is also the amount of the standard deduction for a married couple, so you are in effect getting no tax benefit for any of your spending, relative to someone who had ZERO local taxes, mortgage interest, or charitable donations. That doesn’t sound like a very good deal to me. The IRS expects that the number of taxpayers who itemize will fall from around 33% to 10%.

That poses a problem for charitable giving, because many people will in effect no longer be able to get any tax benefit at all. For people who do regularly give, it’s discouraging. Nonprofit organizations worry that this might reduce how much people are able to give.

We can help you potentially get more of a tax deduction if you can plan ahead for your charitable giving. Here’s how: by using a Donor Advised Fund (DAF). A DAF is a non-profit entity which will hold an account for you, to give grants to charities of your choosing when you instruct them. When you make a deposit into a DAF, you receive a tax deduction that year, even if the funds are not distributed until later years.

Let’s go back to our original scenario and imagine that you plan to give $10,000 a year to charity for the next five years.

Original scenario: You have $24,000 in total deductions each year, same as the standard deduction. Total over 5 years: $120,000, same as every other married couple.

Scenario Two, with a DAF: In year one, you make a $50,000 donation to the Donor Advised Fund and then give out $10,000 a year to your charities as planned. Your total itemized deduction in year one is $64,000. In the following years, you only have $14,000 in itemized deductions, so elect to take the standard deduction of $24,000 (years 2-5). Total over 5 years: $160,000. That’s $40,000 more than the first scenario, even though you still donated the same $10,000 a year to charity. If you are in the 33% tax bracket, you’d save $13,200 in taxes by establishing a DAF in this example.

With a DAF, your gift is irrevocable, however, you can change which charities receive the money and when. Or you can leave the money in the account to invest and grow for later. If you pass away, the DAF is excluded from your taxable estate, and you designate successors such as your spouse or children, who can decide on when and how to distribute money to charities.

If you risk losing your ability to deduct your charitable donations under the TCJA, let’s talk more about the Donor Advised Fund and how it might work in your situation. You can also gift appreciated securities, such as stock or mutual funds, to the DAF and not have to pay capital gains tax on those assets when you fund the DAF. That can give you a double tax benefit.

As your Financial Advisor, I can help you establish a Donor Advised Fund that will be held at our custodian, TD Ameritrade, using the Renaissance Charitable Foundation. This means your account will still be held with your other accounts and professionally managed to your objectives. While a DAF is clearly more cost effective than establishing a Private Foundation with under $1 million in assets, even many ultra-wealthy families find that a DAF can accomplish their philanthropic goals with less expense, compliance headaches, and time commitment.

One other option to get a tax benefit on your charitable donations: If you are over age 70 1/2, you can make a charitable donation directly from your IRA in place of your Required Minimum Distribution. See my previous article on the Qualified Charitable Distribution. The QCD reduces your above-the-line income, so you do not have to itemize to receive a tax benefit for your donation.

Charitable giving is near and dear to our hearts at Good Life Wealth Management. We donate 10% of our gross profits annually to charity and will continue to do so as we grow. Charitable giving is never just about the tax deduction, of course. But if we can stretch those dollars further, we have an opportunity to make an even bigger impact with the donations we make.

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Introducing our Ultra Equity Portfolio

Posted On December 21, 2017 By Scott Stratton, CFP(R), CFA In Portfolio Management /  

We are launching a new portfolio model for 2018, Ultra Equity, a 100% stock allocation. Previously, our most aggressive allocation was 85% stocks and 15% bonds. This type of approach clearly is not for everyone, but if you want the highest possible long-term return and can ignore short-term volatility, Ultra Equity might make sense for you.

Bond yields remain very low today, and bond investors face rising risks, including interest rate risk, that rising interest rates depress bond prices, and purchasing power risk, that inflation eats up all your yield. While defaults have been quite low in recent years, as interest rates rise, it will be increasingly difficult for distressed companies, municipalities, and countries to meet their obligations. The level of debt globally has swelled enormously with the cheap access to capital since 2009, and yet the bond market is acting if all this debt hasn’t changed risks at all.

While the Federal Reserve raised the Fed Funds rate again this week, income investors have been disappointed that there are not more attractive opportunities in bonds today. Unfortunately, the rising rates have not benefited all types of fixed income vehicles equally. On the short end, yes, yields are up. We can now access short-term investment grade bonds with yields of around 1.5% to 2%.

However, the yields on longer bonds have barely moved. The 10-Year Treasury is at 2.35% and the 30-Year remains shockingly low at 2.71%. As a result, we have a “flattening” of the yield curve where short-term rates have increased, but long-term rates are virtually unchanged.

I expect this trend to continue in 2018: rising short-term rates and a flattening yield curve, which means there will continue to be a dearth of opportunities for yield-seeking investors. As a point of reference, the historical rate of return for intermediate bonds was 7.25%, but today, you can’t find anything at even half of that rate. We are always thinking about how we can position portfolio allocations to aim for the best possible return with the least amount of risk and the maximum amount of diversification. But at this point, bonds offer little potential for high returns. Instead, we have to think of bonds as risk mitigators, that the primary purpose of our bonds is to offset the risk we have with our equity holdings.

I’ve been reluctant to roll out a 100% equity allocation with the stock market at an all-time high in the US, because it risks falling into the behavioral trap of becoming too enamored with stocks during a bull market, and ignoring stocks’ volatility and potential for losses. For investors with a horizon of more than 10 or 20 years, there is little possibility that a bond allocation will increase your rate of return. If you are comfortable with ignoring volatility, I think some younger investors may want to invest 100% in equities.

Consider this: the expected return on intermediate bonds is only 3.5% over the next 10 or so years. If you have a 60/40 portfolio and earn 3.5% on your bonds, you will need to make at least 11% on your stocks to reach an overall return of 8%. Many investors are coming to the conclusion that to achieve their goals, the optimal allocation to bonds may be zero.

If you are making regular contributions to an equity allocation, you also have the opportunity to dollar cost average, and buy more shares at a lower price, if the market does drop at some point. And while dollar cost averaging does not guarantee you will not experience losses, it is nevertheless an effective way to accumulate equity assets and possibly benefit from any volatility that does occur.

Our Ultra Equity portfolio will differ from our other portfolio models in that we are not looking to reduce risk or to achieve the best “risk-adjusted” returns. Instead, we will invest tactically in areas where we believe there is the greatest potential for strong long-term rates of return. We will always be diversified, investing in ETFs and mutual funds with hundreds or thousands of different securities, but will have no requirement to hold any specific category of investments.

We cannot know how a portfolio like this will fare over the near term, and there will undoubtedly be times when the stock market is down, sometimes even down significantly. If your attitude is that those drops represent opportunity, rather than adversity, then you should ask us more about Ultra Equity to see if it might be right for you.

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I Had $562 in Unclaimed Property

Posted On December 10, 2017 By Scott Stratton, CFP(R), CFA In Financial Planning /  

Several years ago, I changed firms, and in the process of moving, apparently my old firm did not forward a check for an insurance commission they had received. With the $562 check going unprocessed for more than one year, the insurance company filed an “Unclaimed Property Report” and turned the funds over to the State Comptroller of Texas.

To my surprise, I found my name on a list of unclaimed property and was able to receive this $562 from the state last year. Here in Texas, the Comptroller has returned more than $2 Billion in unclaimed property. Maybe you moved and missed a check? Maybe you had an old bank account that you forgot about? Maybe a company owed you a credit and was unable to reach you?

Here’s how you can find if there is any unclaimed property under your name. You will need to check for each state where you have lived. You can start by going to the website of the National Association of Unclaimed Property Administrators and clicking on your state. Search for your name and city.

For Texas residents, you can go directly to the Texas Site here.

It’s worth spending two minutes doing this, even if you believe as I did, that no one owes you any money. Let me know if you have any success. I hope you do!

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Advantages of Equal Weight Investing

Posted On December 3, 2017 By Scott Stratton, CFP(R), CFA In Portfolio Management /  

The four largest stocks in the United States are all tech companies today: Apple, Microsoft, Amazon, and Facebook. For 2017, these stocks are up significantly more than the overall market, 49%, 38%, 55%, and 52% respectively.

These are undoubtedly great companies, but as a student of the markets, I know you can look at the top companies of previous decades and notice two things. First, top companies don’t stay at the top forever, and second, the market goes through phases where it loves one sector or industry more than it should. (Until it doesn’t…)

And this is the knock on index funds. Because they are weighted by market capitalization, an index will tend to own a great deal of the over-valued companies and very little of the under-valued companies. The top 10 stocks of the S&P 500 Index comprise nearly 20% of its weight today. If you go back to 1999 and look at the valuation of the largest tech companies like Cisco, you can see how those shares were set up for a subsequent period of substantial and prolonged under-performance.

In spite of this supposed flaw in index funds, the fact remains that typically 80% of all actively managed funds perform worse than their benchmark over any period of five years or longer. If the index is hampered by all these over-valued companies, why is it so difficult for fund managers to find the under-valued shares? One possible reason is that the higher expense ratio of an active fund, often one percent or more, eats up the entire value added by the manager.

But there is an interesting alternative to market cap weighting, which avoids over-weighting the expensive stocks. It’s equal weighting. If you have 500 stocks, you invest 0.2% in each company. Your performance then equals that of the average stock, rather than being dependent on the largest companies. To remain equal weight, the fund will have to rebalance positions back to their 0.2% weight from time to time.

There have been extensive studies of the equal weight process, most notably by Standard and Poors which calculates an equal weight version of their S&P 500 Index, and by Rob Arnott, of Research Affiliates, who wrote about equal weighting in various papers and in his 2008 book “The Fundamental Index.”

But even better than studies, there has been an Equal Weight ETF available to investors since April 2003, a 14-year track record through Bull and Bear Markets. The results have been compelling.

– Since inception in 2003, the S&P 500 equal weight fund has had an annual return of 11.21% versus 9.53% for the cap-weighted S&P 500 Index.
– Equal Weight beat Market Cap over 57% of the one-year periods, on a rolling monthly basis since the fund started in 2003. However, the fund out performed over 84% of the five-year periods and 100% of the 10-year periods.
– You might think that by reducing the supposedly over-valued companies, the fund would have lower volatility, but that has not been the case. Instead, the fund has had a slightly higher standard deviation and actually lost more in 2008 than the cap weighted index. It’s no magic bullet; it’s primary benefit appears to be return enhancement rather than risk reduction.

We plan to add an Equal Weight fund to our portfolio models for 2018. Although some of our concern is that today’s tech stocks dominating the index are over-valued, we should point out that there is no guarantee that Equal Weight will be better than the Cap Weighted approach in 2018 or in any given year. However, for investors with a long-term outlook, the approach does appear to offer some benefits in performance and that’s the reason we are adding it to our portfolios.

Before August, the cheapest fund offering an equal weight strategy had an expense ratio of 0.40%. However, there is a new ETF that offers the strategy at an ultra-low cost of only 0.09%, which makes it very competitive with even the cheapest cap weighted ETFs.

If you have any questions on the approach, please feel free to email or call me. For positions in taxable accounts, we have significant gains in many portfolios. In those cases, we will not be selling and creating a taxable event. But we will be purchasing the new fund in IRAs and for purchases going forward.

Source of data: Morningstar.com and from Guggenheim Investments All Things Being Equal dated 9/30/2017.

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Investment Themes for 2018

Posted On November 26, 2017 By Scott Stratton, CFP(R), CFA In Financial Planning /  

Each year, we look closely at trends and valuations to create themes which will be incorporated into our Investment Porfolios. In addition to the Defensive Managers Select portfolio which we highlighted last week, our Premiere Wealth Portfolios are tactical asset allocation models with 10-15 funds or ETFs, at five risk levels: Conservative, with a benchmark of 35% Stocks/65% Bonds, Balanced (50/50), Moderate (60/40), Growth (70/30), and Aggressive (85/15). We are also rolling out a new allocation, Ultra Equity, which will be 100/0.

We will always remain broadly diversified, invested both in Core Assets, which we believe should always be in a portfolio, and in Satellite Assets, which are typically in a more narrow category which we feel offers a benefit to the portfolio at the present time. The Satellite holdings may be changed from year to year, and while the Core funds are “permanent”, their size and weighting in the portfolio will change each year based on their relative valuations and attractiveness of other categories.

We always start with the overall asset allocation in our process, and then choose funds which we think will accurately represent each category. With our themes each year, I think you will see that we are far from being entirely passive. Here are our big picture thoughts for 2018.

1) Foreign over Domestic Stocks. US Equities are quite expensive relative to the rest of the world. The strong performance in 2017 has stretched those valuations even further. We are presently overweight US stocks relative to our benchmark (the MSCI All-Country World Index), but will reduce our weighting to US stocks to an underweight.

2) Overweight Emerging Markets. For 2017, we increased our allocation to Emerging Markets Equities to two-times the level of the index, approximately 17% compared to 8.5%. EM had a phenomenal year in 2017, currently up nearly 30%. When we rebalance, these positions may be trimmed, but please note that we are not reducing our target allocation!

3) Reduce Risk in Fixed Income. While short-term rates rose nicely in 2017, long-term interest rates did not. This was our “low for longer” theme from last year. We sold our high-yield bond ETF over the summer, but will continue to look to reduce the duration of our bond holdings and increase the credit quality. When we do eventually get a correction in the stock portfolio, we want to have high quality bonds to provide support to the portfolio.

4) Increased Volatility. We don’t have a crystal ball and believe that trying to make predictions is not only futile but damaging to your returns. However, we have gone an exceptionally long time without any sort of correction. I don’t know when it will occur, but just as autumn turns to winter, I think investors must not forget that there will be down periods, and be prepared to weather potential storms in 2018 and beyond.

We published Four Investment Themes for 2017 in November of 2016. Click the link if you’d like to see how we did. I think we were generally successful in identifying themes for this year, except that I was expecting Value stocks to take the lead from Growth stocks, which did not occur. However, we saw the gap in valuation between Value and Growth widen in 2017, so I believe that Value offers less risk and potentially a higher long-term return than Growth.

2017 was the first full year to include a 10% allocation to Alternatives within each portfolio. With the stock market producing double digit returns in many categories, our investment in Alternatives was a drag on performance. Still, I think many investors will appreciate that we are looking for more stable sources of returns than just being in stocks and bonds. With high valuations in domestic stocks, and low bonds yields globally, risks remain elevated.

Overall, we will be making only small adjustments to our portfolios for 2018. But compared to two or three years ago, we have already made significant changes to reduce risk and further diversify our portfolios. As always, I am happy to discuss our investing approach in greater detail with anyone who is interested.

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Can You Contribute to an HSA After 65? (Updated for 2026)

Posted On November 12, 2017 By Scott Stratton, CFP(R), CFA In Retirement Planning /  

Bottom Line: You cannot make new contributions to a Health Savings Account (HSA) once you’re enrolled in Medicare (any part). But you can continue to use the funds you’ve already accumulated, and you gain additional flexibility in how distributions are treated after age 65.

Overview: HSA Eligibility and Medicare

A Health Savings Account (HSA) gives triple tax benefits — deductible contributions, tax-free growth, and tax-free withdrawals for qualified medical expenses — but you must be covered by a qualifying High Deductible Health Plan (HDHP) and not have disqualifying coverage (like Medicare) to contribute.

Once you enroll in Medicare (Part A, B, C, or D), contributions stop because Medicare is no longer an HDHP and therefore disqualifies you from making further HSA contributions.

➡️ Many people receive Medicare Part A automatically when they start Social Security benefits at age 65, which also ends eligibility to contribute.

Can You Contribute While Working Past 65?

If you are still working past age 65 and are enrolled in an HDHP that qualifies for an HSA and you haven’t enrolled in Medicare, you can continue contributing. The key conditions are:

  • You remain covered under an HDHP;
  • You’re not enrolled in any part of Medicare; and
  • You otherwise meet IRS eligibility rules.

Many retirees choose to delay Medicare enrollment (and sometimes Social Security) so they can continue making HSA contributions for a short period — but this requires careful coordination with benefits and tax rules.

What Happens If You Contribute After You Enroll in Medicare?

If you contribute to your HSA after Medicare coverage begins, those contributions are considered ineligible and cause an excess contribution, which can trigger:

  • A 6% excise tax on the excess amount for each year it remains in the HSA; and
  • The requirement to withdraw the excess amount (plus earnings) to avoid further penalties.

This means careful planning is important if you’re close to Medicare age or delaying enrollment.

How Much Can You Contribute the Year You Turn 65?

In the year you reach age 65 and enroll in Medicare:

  • Your annual HSA contribution limit may be prorated based on the number of months you were eligible under an HDHP before Medicare coverage began.
  • Delaying Medicare enrollment can affect your eligible months.

Always confirm contribution limits with your plan administrator and consider tax implications when planning contributions around the year of Medicare enrollment.

Using HSA Funds After 65

While you can’t contribute after Medicare enrollment, your existing HSA assets remain yours and may be used:

  • Tax-free for qualified medical expenses, including deductibles, co-pays, prescription drugs, vision and dental care. Additionally, you can use your HSA to reimburse Medicare Parts B and D premiums and Medicare Advantage costs;
  • For non-medical expenses after age 65 without the usual 20% penalty (but such withdrawals are taxable like distributions from a traditional IRA). This should be avoided, if possible.

This makes an HSA a flexible part of retirement expense planning.

Planning Considerations for Retirees

Before age 65, an HSA can be an efficient way to build tax-advantaged savings for future healthcare needs. Once you’re approaching Medicare eligibility:

  • Coordinate your HDHP coverage, Social Security timing, and Medicare enrollment;
  • Understand proration rules for your final year of HSA eligibility; and
  • Be mindful of potential tax penalties for excess contributions.

Many retirees find HSA coordination fits into broader decisions about retirement income sequencing and tax planning — see our guide on Retirement Tax Planning for related context.

Related Resources

Frequently Asked Questions (Retiree Focused)

Q: Can I still use my HSA to pay Medicare premiums?
Yes. After age 65, you can use your existing HSA funds to pay for qualified medical expenses, which include many Medicare premiums (Part B, Part D, Medicare Advantage).

Q: Is there any penalty if I withdraw HSA funds for non-medical expenses after age 65?
No penalty applies after age 65, but withdrawals for non-medical expenses are taxable as ordinary income.

Q: What if I delay enrolling in Medicare to keep contributing to my HSA?
You may remain HSA-eligible if you delay Medicare enrollment and maintain HDHP coverage — but retroactive Medicare coverage (up to six months) can catch you if you later enroll, making careful timing essential.

Q: Does enrolling in just Medicare Part A trigger the contribution restriction?
Yes. Enrollment in any part of Medicare — including Part A — ends your eligibility to contribute to an HSA.

If you’re approaching Medicare eligibility or are already managing multiple sources of retirement income, coordinating HSA rules, tax timing, and Medicare decisions can make a meaningful difference in your long-term planning. If you’d like a second look at your situation from a planning-first perspective, consider scheduling a conversation: Request an Introductory Conversation.

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Are Your Tax-Deductions Going Away?

Posted On November 5, 2017 By Scott Stratton, CFP(R), CFA In Tax Strategies /  

Last week, we discussed the current tax reform proposal in Washington and discussed how it would reduce incentives for homeowners two ways: by increasing the standard deduction and by eliminating the deduction for state and local taxes, including the deduction for property taxes. Recall that itemized deductions only are a benefit if they exceed the amount of the standard deduction, currently $6,350 single or $12,700 married.

While the legislation has yet to be finalized, it appears increasingly likely that we are on the eve of the most significant tax changes in 30 years. The proposals are slated to take effect in 2018, which means that if they are approved, there is still several weeks in 2017 to make use of the old rules.

For many Americans, your taxes will be lower under the current proposal. The biggest tax cuts, however, would go to corporations, with a proposed reduction from 35% to a maximum of 20%. That’s the proposal, but the final version may be different. The advice below is based on the current GOP plan; we would not advocate taking any steps until the reforms are in their final version and passed.

1. Itemized Deductions. The proposal would increase the standard deduction from $6,350 (single) and $12,700 (married) to $12,000 and $24,000. As a result, it is believed that instead of 33%, the number of taxpayers who itemize will fall to only 10%. If you have itemized deductions below $12,000/$24,000, you will no longer receive any benefit from those expenses in 2018.

  • Consider accelerating any tax deductions into 2017, such as property taxes, charitable donations, or unreimbursed employee expenses.
  • Itemized deductions for casualty losses, gambling losses/expenses, and medical expenses will be repealed.
  • Many miscellaneous deductions will disappear, including: tax preparation fees, moving for work (over 50 miles), and unreimbursed employee expenses.
  • Investment advisory fees, such as those I charge to clients, will still be tax deductible. However, these miscellaneous deductions only count when they exceed 2% of AGI, which will be more difficult to achieve with so many other deductions disappearing.
  • The $7,500 tax credit for the purchase of a plug-in electric vehicle will be abolished. If you were thinking of buying a Chevy Bolt or Nissan Leaf, better do so now! If you are on the wait list for a Tesla Model 3, you probably will not receive one before the credit disappears. Read more: “Is Your Car Eligible for a $7,500 Tax Credit?”

2. Real Estate. The Senate version we discussed last week had completely eliminated the deduction for property taxes and state/local taxed paid. Luckily, this has been softened to a cap of $10,000 for property taxes.

  • If your property taxes exceed $10,000, you might want to pay those taxes in December as part of your 2017 tax year. If you pay in January 2018, you would not receive the full deduction.
  • The proposal also caps the mortgage interest deduction to $500,000, and for your primary residence only. This is a substantial reduction. Currently, you can deduct interest on a mortgage up to $1 million, and you can also deduct mortgage interest on a second home, including, in some cases, an RV or yacht.
  • Many owners of second homes will likely try to treat these as investment properties, if they are willing to rent them out. As a rental, you can deduct taxes and other costs as a business expense. See my article: “Can You Afford a Second Home?”

3. Tax Brackets. The proposal reduces the tax brackets to four levels: 12%, 25%, 35%, and 39.6% (the current top bracket remains). These brackets are shifted to slightly higher income levels, so many taxpayers will be in a lower bracket than today or pay less tax. Those in the top bracket, 39.6%, who also make over $1 million, will have their income in the 12% range boosted to the 39.6% level. So don’t think this proposal is excessively generous to high earners – many will see higher taxes.

The Alternative Minimum Tax (AMT) will be abolished, so if you have any Minimum Tax Credit carryforwards, those credits will be released. The 3.8% Medicare Surtax will unfortunately remain in place, even though Trump has previously promised to repeal it. Capital Gains rates will remain at 0%, 15%, and 20% depending on your tax bracket, and curiously, these rates will be tied to the old income levels, and not to the new tax brackets.

If passed, the tax reform bill will substantially change how we deduct expenses from our taxes. Those with simple returns may find that their tax bill is lower, but for many investors with more complicated tax situations, the proposed changes may require that you rethink how you approach your taxes.

We will keep you posted of how this unfolds and will especially be looking for potential ways it may impact our financial plans. It has often been said that the definition of a “loophole” is a tax benefit that someone else gets. Unfortunately, simplifying the tax code and closing these deductions is bound to upset many people who will see their favorite tax benefits reduced or removed entirely.

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Home Tax Deductions: Overrated and Getting Worse

Posted On October 29, 2017 By Scott Stratton, CFP(R), CFA In Tax Strategies /   2 Comments

If you ask virtually anyone about the benefits of home ownership, you will probably hear the phrase “great tax deductions” within 20 seconds. However, the reality is that for many taxpayers, owning real estate is not much of a tax deduction at all. And under the Trump-proposed tax reform bill currently in Congress, the actual tax benefits homeowners achieve will shrink vastly.

The two main tax benefits of being a homeowner are the mortgage interest deduction and the property tax deduction. These are claimed under “itemized deductions”, which also include charitable donations, medical expenses (exceeding 7.5% or 10% of income), and miscellaneous deductions such as unreimbursed employee expenses.

You have your choice of taking whichever is higher: the standard deduction or your itemized deductions (Schedule A). The standard deduction for 2017 is $6,350 (single) or $12,700 (married filing jointly). So, the first thing to realize about home tax deductions is that you only are getting a benefit if they exceed $6,350/$12,700.

If you are married and your mortgage interest, property tax, and other deductions only total $11,000, you will take the standard deduction. All those house expenses did not get you a penny of additional tax benefits. If your itemized deductions total $13,000, you would take the itemized deductions, but are only getting a benefit of $300 – the amount by which you exceeded the standard deduction.

The greatest proportion of tax benefits for homeowners go to those with very expensive homes and large mortgages. People with more modest homes may be getting little or no benefit relative to the standard deduction. But wealthy taxpayers can have their itemized deductions reduced by up to 80% under the Pease Restrictions. So, I have also seen high earning families who don’t get to count their home expenses either, and have to take the Standard Deduction!

The proposal in Congress today via President Trump would make two significant changes to tax deductions for homeowners:

1. The bill would almost double the standard deduction from $6,350 (single) and $12,700 (married) today to $12,000 and $24,000. This would reduce taxes and eliminate the need for itemized deductions for many American families. If you are married and your current itemized deductions are under $24,000, you would no longer be getting a deduction for those expenses.

2. Trump also proposes eliminating the deduction for State and Local Taxes (the so-called SALT deductions), which includes property taxes. Removing the SALT deduction from Schedule A would be devastating for high tax states like California, New York, Connecticut, and New Jersey. But it would also harm many homeowners right here in Texas, where our property taxes can be a significant expense.

While the increase in the standard deduction would offset the loss of SALT deductions for many Americans, it is still an elimination of a key benefit of being a homeowner. The current tax reform bill has narrowly passed in the House of Representatives and will be taken up by the Senate after November 6, where it requires only a simple majority to pass under budget reconciliation rules.

The fact is that real estate tax deductions were already overstated when you recognize that you only benefit when you exceed the Standard Deduction. The first $12,700 in itemized deductions achieve no reduction in taxes whatsoever. Now, if Congress acts to increase the Standard Deduction and to eliminate the ability to deduct property taxes, most people will not be getting any tax break from being a homeowner.

Depending on your situation, your overall tax bill may still go down. The current proposal will simplify the tax brackets to just three levels: 12%, 25%, and 35%. Your taxes may also go down because of the increase in the Standard Deduction, provided the Standard Deduction is higher than your Schedule A.

Tax policy has a profound influence on public behavior. If you know that you are not getting any additional tax benefit from being a homeowner, you may prefer to rent. If you are retired and see your income taxes go up, you may decide to sell your home and downsize to save money. This change in policy may have the unintended consequence of hurting home values, too, because it certainly make being a homeowner less appealing.

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Big Changes to Ameritrade’s ETF Platform

Posted On October 22, 2017 By Scott Stratton, CFP(R), CFA In Portfolio Management /  

Exchange Traded Funds (ETFs) are a terrific vehicle for investors, offering an easy way to build diversified portfolios that are transparent, tax efficient, and low cost. We’ve written frequently about the advantages of ETFs and hold them as core positions within all of our portfolios.

This week, our custodian, TD Ameritrade, announced that it was expanding its platform of commission-free ETFs from 100 to nearly 300 funds. Wonderful, right? Not so fast… while the total number of ETFs will increase, they are actually dropping 84 low-cost ETFs, including ALL of the Vanguard ETFs we use for each and every client.

To say that we are disappointed and frustrated is an understatement. We are big fans of Vanguard and have used these funds since we opened three years ago. They are among our largest holdings. Why is TD Ameritrade dropping these funds? Distribution fees. Vanguard does not pay custodians to distribute their funds, but other companies will pay TD Ameritrade to be on their commission-free platform.

As a whole, the changes to the TD Ameritrade platform are appalling to me. We lose low cost ETFs from Vanguard and the iShares Core series, and instead are offered mainly niche ETFs with high expense ratios. Many of the new ETFs are focused on a very narrow area such as the “nasdaq smartphone index” or the “dynamic pharmaceuticals” ETF. This approach is antithetical to our process of diversification. Sometimes being given more options does not mean that you have better choices.

There is one bright spot: they are adding the new SPDR Portfolio Series from State Street. State Street is one of the three largest ETF providers, along with Vanguard and iShares, and is the creator of the original S&P 500 ETF, SPY,  which launched the whole ETF movement nearly 20 years ago.

In recent years, State Street has been struggling to keep up with lower cost competition from Vanguard, Schwab, iShares and others. The new Portfolio Series took a handful of their most diversified ETFs, many with track records of over 10 years, and slashed the expense ratios to levels at or below even Vanguard. These will be our new go-to funds.

We can of course, continue to buy and sell the Vanguard ETFs through TD Ameritrade. However, after November 16, those trades will incur a standard commission (as low as $6.95). And that is still a bargain. Should we drop our Vanguard funds in the next month, while they still trade for commission-free?

Here is our plan:

1. In taxable accounts, we may have significant capital gains in our Vanguard positions. It does not make sense to realize thousands of dollars in gains just to avoid a $6.95 commission. (If we had losses, we would harvest those losses, but the market is up nicely this year. I’m not complaining!)

2. Even when there is zero commission, there are still trading costs. Just like stocks, ETFs trade in an auction process where buyers offer a “bid” and sellers request an “ask” price. The Vanguard ETFs are heavily traded, sometimes with multiple trades in one second. The difference between the bid and ask price, the “spread”, is often only one cent.

However, on ETFs that trade less frequently, the spread can be much higher. I looked at a small-cap value ETF this week that had a 14 cent spread. So, even in non-taxable accounts like IRAs, there may still be a hidden cost if we were to sell Vanguard to buy the SPDRs. As trading volume increases, I anticipate bid-ask spreads will tighten on the newly added funds. But for larger positions, selling one ETF at the bid and buying another at the ask could certainly cost more than the $6.95 commission we are trying to avoid.

3. For new purchases, we will use the SPDR Portfolio Series, effective immediately. They trade commission-free and in many cases have a lower expense ratio than a comparable Vanguard Fund. Existing portfolios will continue to hold Vanguard Funds. This means that many portfolios will unfortunately now have some duplication, where for example, we might own a Vanguard International ETF and also own a similar SPDR International ETF. I try to avoid that sort of redundancy, but it does not really cause any harm.

4. In IRAs with smaller positions, we will look to sell Vanguard within the next few weeks and replace those positions with a new commission-free option. We will still be needing to rebalance portfolios annually, in which case, it is nice to be able to do so commission-free. These trades will be done on a case-by-case basis.

Please feel free to email or call me with any questions. This change at TD Ameritrade has created some temporary hassle, and received quite negative press on Wealth Management.com and in a scathing piece by Michael Kitces.

This change isn’t going to detract from our approach or impact our investment process. We start with a top down asset allocation and then choose the best fund to fulfill each segment of our allocation. We certainly don’t limit our search for investments to just commission-free ETFs, and have always also had mutual funds or ETFs that are not on the commission-free platform. As your Fiduciary, we take seriously our responsibility to keep fees as low as possible, but it’s not true that the lowest cost is always the best investment option.

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