Charitable Giving Rules and Strategies

Posted On September 19, 2016 By Scott Stratton, CFP(R), CFA In Financial Planning /

Is Charitable Giving part of your financial plan? It is part of ours. At Good Life Wealth Management, we donate a minimum of 10% of pre-tax profits annually. We believe that charitable giving is the ultimate expression of financial freedom. Having the ability to help others and make the world a better place, without fear of running out of resources for ourselves, is perhaps the best definition of financial independence. So many people have helped us get to where we are today, it is only right that we look to make a difference through our work, our time, and our financial support.

The IRS rules behind deducting your donations are not well understood by most taxpayers. There are strategies which can make your giving dollars go farther. Even if you have been making charitable gifts for many decades, chances are that you will learn something new in this article.

1) Qualified Charities. If you are wondering whether your donation to a particular organization is tax-deductible, check the IRS database: Exempt Organization Select Check. There are some organizations, such as political parties or candidates, fraternal organizations, chambers of commerce, or lobbying groups, which are not eligible for tax-deductible donations. Donations to individuals are not tax deductible, either.

2) Deduction limits. Charitable donations are part of itemized deductions. If you take the standard deduction, you are not getting any tax benefit from your charitable giving. If this is the case, try alternating years of itemized and standard deductions. Aim to “stuff” all your itemized deductions into one year. For example, you can pay your property taxes in January and then again in December, which puts two years of deductions into one year for tax purposes. Do the same with your charitable giving

There are limits to how much you can deduct, based on on your Adjusted Gross Income (AGI). If your donations are more than 20% of your AGI, you need to know these rules:

For most charities, you can deduct donations up to 50% of AGI.
If you donate Capital Gain Property, the limit is 30%.
For certain charities, including private foundations, veterans’ organizations, and non-profit cemeteries, the limit is 30%.
Capital Gain Property donated to 30% organizations is limited to 20% of AGI.
If you exceed these limits, the good news is that the excess will carry forward for the next five years.

Lastly, your itemized deductions – including charitable donations – may be reduced under the Pease limitations for high income earners.

3) Cash Donations. Cash donations under $250 may be substantiated with a cancelled check or credit card statement. Donations over $250 require an acknowledgement from the organization. Please note that if you receive anything in return for your donation (event tickets, T-shirt, etc.), the value of the goods or services received must be subtracted from the value of the donation. Most tickets to charity events, raffles, or contests are non-deductible.

4) Non-Cash Donations. Non-Cash Donations are an area of scrutiny for the IRS, and the record keeping requirements are more strict. You are limited to the fair market value of goods donated, and generally, not your cost basis in the items donated.

Under $250. A receipt from the organization, including a “reasonably detailed description” of the property. You may determine the value, but need to document how you calculated the value.
$250-$500. You must have a receipt from the organization, including the value of the items donated.
$501-$5,000. In addition to the requirements above, you must document how you acquired the property, when, and your cost basis. If you are donating an item to a charity auction, the receipt from the organization should indicate the amount that the item sold for, which could differ significantly from your opinion of value.
Over $5,000. You must also obtain a written appraisal from a qualified, independent appraiser.

5) Appreciated Securities. If you are planning on making larger donations, it may be worthwhile to donate appreciate securities (shares of stock, mutual funds, etc.) rather than making a cash donation. You still get the full value of your donation (and the charity gets the full amount), but you also will avoid paying capital gains tax on those securities. Since the charity is a tax exempt organization, they pay no capital gains when they sell your securities.

For example, consider a donation of $10,000. You could donate cash, or a $10,000 of a fund. Yous cost basis in the fund is $4000, so you would have a gain of $6000. At a 15% capital gains rate, you would avoid $900 in capital gains. If you are in the top bracket, you pay 23.8% for long-term capital gains, so you would save $1,428 in this example.

If you want, you can put the $10,000 cash you were planning to donate into your brokerage account and immediately repurchase your shares. There’s no waiting period or wash sale on donating gains! Now you have made your donation as planned, avoided some capital gains, and still have the same number of shares, but have reset your cost basis higher. Win-win-win.

6) IRA RMD. Last year, Congress made permanent the rules on Qualified Charitable Distributions from your Individual Retirement Account. If you are over age 70 1/2, you can make a distribution directly from your IRA to the charity of your choice, in fulfillment of your Required Minimum Distribution. I wrote in detail about who should use this benefit here: Qualified Charitable Distributions From Your IRA.

7) Donor Advised Fund (DAF). Also called a Charitable Gift Fund, a DAF is a charitable fund that allows you to make a tax deductible donation today, invest those funds, and distribute money to charities of your choice in the future. The DAF is itself a public charity, so your creating and funding an account is tax-deductible. It is also permanent and irrevocable, so plan carefully! Once funded, you can purchase various investments, such as cash, mutual funds, or other securities.

A DAF is great if you have significant windfall in one year – for example, through the sale of a business or real estate – and want to plan ahead for future giving. For example, you could put $100,000 into the fund, and receive a $100,000 deduction this year. You can subsequently make donations for the next 20 or 25 years, if you wanted to. A DAF is often a better solution than setting up a private foundation for family giving. If you have a significant financial event, you may be pushed into the top tax bracket of 43.4%. If that happens, every $1000 you put into a DAF will save you $434 in taxes. If you were ultimately planning to give that money to charity in the future, it would be crazy to not look at keeping more of your money out of the hands of the IRS today.

While the gift to the DAF is irrevocable, you still control the disbursements from the account, so you can decide when, to whom, and how much you give. You may love a charity today, but 10 years from now may find another that you feel is more deserving. This may be preferable to donating a significant amount to one charity in a single year. A DAF is also a great way to involve your children or grandchildren in your family’s philanthropy.

Certainly the purpose of Charitable Giving is not to get a tax-deduction. But if the government is going to give us financial incentives to encourage our donations, we should take advantage of those opportunities. Significant tax savings today means that you will have more money left over to donate in the future. Why pay 15% to 43.4% (or 50%+ in California, New York, and other states) tax on each dollar you donate?

Many people prefer to leave gifts to charity through their will. While this has the advantage of making sure you do not run out of money while you’re alive, you lose the benefit of reducing your income taxes today. If you have more than enough money, it may be preferable to give while you are alive, to enjoy seeing the good your money can do. That will give you better tax benefits, and also avoids problems with your will.

I know of a deceased individual (not a client) who planned to leave several million to charity and “only” $1 million to each child. The children are contesting the will and besides tying up the money for years, attorney’s fees will end up reducing the proceeds by at least $1 million. This tragic situation of a contested will is all too common, but could be avoided with better planning and communication. That’s where professional advice can help.

How can we help you with your charitable planning?

6 Steps at Age 60

Posted On September 12, 2016 By Scott Stratton, CFP(R), CFA In Retirement Planning / 1 Comment

The sixties are a decade of financial change. Are you prepared? Here’s my checklist to confirm if your finances are in good order at age 60.

1) 12.5X annual income. At this point, you should have saved at least 12.5 times your annual income in your investment and retirement accounts. Why 12.5 times? When you retire, we will recommend an initial 4% withdrawal rate. To replace one-half your income from investments, you would need 12.5X. For example, if your income is $100,000, we’d want at least $1,250,000 in investments to provide $50,000 a year in distributions.

Why replace only half your income? Won’t that be a significant drop in your standard of living? As an employee today, you are subject to payroll taxes (7.65%) which will not apply to your retirement income. Since you are saving today for retirement, that “expense” will go away in retirement. Plus the 50% is only withdrawals – when we include Social Security, and possibly pension income, your income replacement rate may be 70% or higher.

You may disagree with this, because at age 60, you have no immediate plans to retire. Therefore, you think this does not apply to you. Wrong. The 2016 Retirement Confidence Survey from the Employee Benefits Research Institute finds “a considerable gap exists between workers’ expectations and retirees’ experience about leaving the workforce.” Although 37% of workers expect to work past age 65, only 15% of retirees actually retired at this age. Most reported retiring for reasons beyond their control, such as layoffs, health issues, or family reasons. So, just because you plan to keep working does not guarantee that you will actually be able to do so.

Even if you do not retire for another five years, the market might not be higher over this short time frame. Certainly that was the experience for people who retired in January of 2009. If you already have 12.5X your income by age 60, then you aren’t dependent strong market performance in your last years of work to get you to the finish line.

2) Estate plan. If your will and documents are more than five years old, it’s time to revisit your estate plan for an update. This should include:

Checking the beneficiaries on your retirement plans, IRAs, life insurance, and annuities.
Updating your Will.
Establishing Directives and Powers of Attorney if you should become incapacitated.
Considering if you have the potential for an Estate Tax liability; considering whether trusts are needed for asset protection, tax planning, or special needs.

3) Health Care. Modern healthcare is extending the human lifespan. Even more significant than the added years is the high quality active lifestyle that people are leading in their seventies and even eighties today. Many of the miracles of modern medicine are in the early detection, treatment, and cure of common diseases such as cancer and heart disease. If you want to enjoy these life-saving advances, you have to participate and have regular screenings and testing as recommended by your physician. Don’t ignore minor symptoms, bring them to your doctor’s attention as soon as possible.

I think many of us are reluctant to go see a doctor when we feel well or can find an excuse to not go. Without your health, you are not going to be able to enjoy the fruits of your decades of work. Make a small, but essential, investment in your future by taking care of your self.

4) Long-Term Care Plan. Note, this says plan, it does not say insurance. Not everyone needs to have Long-Term Care Insurance, some people can afford to self-insure. No one wants to think of themselves as being in a nursing home. However, as people are living longer, more of us will need assistance. Today, many LTC insurance policies include coverage for home health care and aides, meaning that the policy may actually be the reason why you can stay at home and not have to go to a nursing home.

At age 50, people aren’t interested in buying LTC when it is 30+ years away. At age 70, a policy will be prohibitively expensive, and you won’t want to buy one even if you could afford it. Age 60 is the sweet spot for buying LTC insurance. Here’s what you should do: determine if you can afford long-term care in the future without the insurance. If not, contact me for more information. If leaving money to heirs or charity is a top priority for you, you should actually consider the insurance as it will reduce the possibility of depleting your assets if you should need care.

5) Social Security Statement. Create your account on ssa.gov and download your statement.

These estimates assume you continue to work until the age of retirement. Know your Full Retirement Age, and learn about how benefits are reduced for early retirement and increased for delaying up to age 70.
The spouse with the higher benefit will provide a benefit for both lives, under the survivorship benefit. Therefore, you should try to maximize the benefit of the higher earning spouse by delaying, if possible, to age 70.
Statements do not list spousal benefits, and all amounts are in today’s dollars. Benefits will accrue Cost of Living Adjustments to keep pace with inflation.

6) Health Insurance. Keeping your benefits is essential until age 65, when you become eligible for Medicare. When you do receive Medicare, you will still have to pay premiums for Part B, as well as any Supplement, Advantage, or drug plans. Don’t neglect to include these costs in your retirement budget!

Back in 2008, I realized that many of my clients had similar questions once they were within five years of retirement. This is a crucial final period of preparation for your decades ahead. To help educate pre-retirees about these issues, I wrote Your Last 5 Years: Making the Transition From Work to Retirement as your guidebook. Email me for a copy or order one from Amazon!

The 9 Profiles of Wealth

Posted On September 5, 2016 By Scott Stratton, CFP(R), CFA In Behavioral Finance /

Based on interviews and surveys of nearly 900 families, Russ Alan Prince found that their attitudes toward investing could be broken into nine distinct psychological categories. These brief descriptions really do describe most of the investors I have met in my career. Just from looking at this list, do you identify with one of these types?

Here are the 9 Profiles of Wealth, in order of largest to smallest percentage of the study’s results.
1) Family Stewards (20.7% of the sample)
Successful investing allows them to provide for their family, relieve financial worry, and fulfill personal obligations.
2) Investment Phobics (17.0%)
Dislike discussing investments and dislike having to make investment decisions.
3) Independents (12.9%)
Investing provides personal freedom and eliminates worries. Not excited by investing, it’s a necessary evil.
4) The Anonymous (11.8%)
Prize confidentiality and privacy. Concerned about losing money, but view investments as crucial for personal comfort.
5) Moguls (10.1%)
Wealth is a way of keeping score, becoming influential and powerful.
6) VIPs (8.4%)
Successful investing results in prestige and being well known.
7) Accumulators (7.6%)
Solely focused on making money. A person can never be too rich.
8) Gamblers (6.0%)
Enjoy investing, it’s their passion and hobby. Derive pleasure from speculating.
9) Innovators (5.5%)
Investing is an intellectual challenge that requires staying up to date on new opportunities and the latest technologies.

Owning nice things – as a measure of affluence – tends to be most important to Accumulators, VIPs, and Independents. Family Stewards, Investment Phobics, and Gamblers are the least interested in material things and may even view spending as contrary to their goals. The other categories fall in the middle of consumption attitudes.

Most of these nine profiles are going to greatly appreciate the benefits of our financial planning program and wealth management services. Depending on your profile and risk tolerance, we can custom tailor your plan for you. Whatever your needs, you can expect:

Confidence. A plan designed to achieve your goals, which enables you to feel optimistic about your financial future.
Competence. Evidence-based analysis is the basis our financial planning steps and investment processes. We stay abreast of current regulations, research, and best practices. Our experience, knowledge, and professional insight are in service of your needs.
Caring. Clients come first. Our fiduciary promise is to do what is in your best interest. Your long-term success is our one and only mission.

Learn more about Our Financial Planning Services.

To Roth or Not to Roth?

Posted On August 29, 2016 By Scott Stratton, CFP(R), CFA In Retirement Planning /

The question of “Roth or Traditional” has become even more complicated today with the advent of the Roth 401(k). Which should you choose for your 401(k)? Like many financial questions, the answer is “it depends”.

In asking the same question for an IRA, investors often look at their eligibility for the Roth versus their ability to deduct the Traditional IRA contribution. For the 401(k), that’s not an issue – there are no income restrictions or eligibility rules for a Traditional 401(k) or a Roth 401(k). You should also know that while you may choose Roth or Traditional contributions, any company match will always go in the Traditional bucket.

How to choose, then? Here are five considerations to making the decision:

1) If you are going to be in a lower tax bracket in retirement, it’s preferable to defer taxes today and pay taxes later. If this describes your situation, then you are likely better off in the Traditional 401(k). A majority of people should have an expectation of lower taxes in retirement.

2) The problem is that we don’t know what future tax rates will be. We do know that we are running massive budget deficits and that the accumulated national debt is a growing problem. While every politician wants to promise lower taxes to get votes, that seems unrealistic as a long-term solution to our budget issues. Retirees are often surprised that their taxes do not in fact vanish in retirement. Pension, Social Security, RMDs, etc. are all taxable income.

Link: Taxes and Retirement

If you believe you will be in the same or higher tax bracket in Retirement, then the advantage goes to the Roth. While you will not realize a tax benefit today from a Roth contribution, your money will grow tax-free. If you are going to pay the same tax rates in the future as today, you would be indifferent, in theory. Except that…

3) When you reach retirement, a $1 million Roth gives you $1 million to spend, whereas $1 million in a Traditional IRA or 401(k) may be worth only $750,000, $600,000, or less after you take out Federal and State income taxes. This means saving $18,000 in a Roth 401(k) is worth more than the same $18,000 in a Traditional 401(k), because the Roth money will be available tax-free.

If you are in a lower tax bracket or can comfortably pay the taxes, then the Roth may be preferable. In retirement, if you have both Roth and Traditional accounts, you can choose where to take withdrawals to best manage your taxes. (We call this tax diversification.)

4) The only caveat to the Roth contribution is that contributing to a Traditional 401(k) can lower your Adjusted Gross Income (AGI). If having a lower AGI would make you eligible for a tax credit, or eligible for an IRA contribution, then it may be beneficial to choose the deductible contribution.

For example: The Saver’s Tax Credit

5) There are no Required Minimum Distributions from a Roth account. If you are in the fortunate position to have plenty of retirement assets, making Roth contributions will add to tax-free assets, rather than creating an RMD liability for when you turn 70 1/2.

Last thought: for the past two decades, I have met people who don’t want to invest in a Roth because they think the government will take away the tax-free benefit in the future. I don’t see this happening. The government actually prefers Roths because it increases current tax revenue rather than the Traditional, which decreases current taxes. And I don’t see Roth accounts being used or abused by Billionaires or corporations – the amounts are so small and used mainly by working families.

Can You Afford a Second Home?

Posted On August 22, 2016 By Scott Stratton, CFP(R), CFA In Financial Planning /

When asked to describe their idea of living The Good Life, many investors tell me that they have a special place – a lake, mountain, beach, or city – that is near and dear to their heart. Their dream is to have a get away, not at retirement, but now to spend with their families and build the memories that will last a lifetime. If you find yourself constantly dreaming about that perfect Florida beach or the stillness of a snow-capped Colorado peak, it won’t be long before you find yourself Googling home prices in your favorite vacation town and thinking about the possibilities.

Having a second home is a wonderful thing, when done properly. It can also be stressful, time-consuming, and an enormous financial drain which can impact your financial stability and even your solvency. When the financial crisis hit, buyers of vacation properties disappeared, leaving cash-strapped owners in a tragic process of liquidating properties at enormous losses.

Today, prices have recovered and in many areas are back to fresh highs. Not only have bargains largely disappeared, prices have been driven up in popular locations by foreign investors who want to get money out of their own country and into the stability of US dollars. For many international investors, it is easier to buy US real estate than it would be to open a brokerage account in the US.

If you are contemplating buying a second home, be smart and make sure your decisions are based on a thorough and comprehensive examination of the financial details involved. For our financial planning process, that would mean adding in the realistic costs of a second home into our software and examining the results. Would the drain of a second home crowd out other cash flow goals such as retirement? Would you have to delay retirement by several years to keep your retirement success above 80 or 90 percent?

I own a second home, and have spoken with dozens of clients about their experiences over the years. Here’s my advice if you’re thinking of taking the plunge:

1) A second home is not an investment. It’s great if your Uncle made millions off the property he bought in Beaver Creek in 1976, but this is 2016. Very few people make money off their vacation properties, and even fewer actually consider their total costs of interest, taxes, insurance, upkeep, and utilities, when making a profit calculation. In other words, buying a condo for $400,000 and selling it for $450,000 five years later means you probably lost money. A 6% real estate commission would immediately reduce your proceeds from $450,000 to $423,000. Take out your other costs and you almost certainly have a negative return, even if you have a capital gain for tax purposes.

When we want something, our mind will go to great lengths to rationalize why it is a good idea. I once had a client bring me a spreadsheet showing the value of a condo in Hawaii increasing by 9% a year for the next 40 years. Why? Because he said it was a fact that condos in Hawaii increase by 9% every year.

I’m not saying a second home is a bad idea, but it’s best to not start with rose-colored glasses thinking that it will be a killer investment. Instead, examine the costs of a second home and calculate if you can afford this expense as part of your lifestyle. If, after many years of enjoyment, you were to turn an actual profit, consider yourself fortunate to have had such good luck.

2) If you are only going to be there two weeks a year, you will probably be better off staying at a hotel or rental rather than buying a property. This is not only likely to be the less expensive route, it also frees you from the mental and emotional drain of having a second home. Besides paying more bills, you have the difficulty and hassle of maintaining a property that is hundreds or thousands of miles away.

Don’t worry, there are management companies to look after your property, right? Yes, for a cost. Thinking that you can effortlessly rent out your vacation property when you are not there and it will pay for itself? While you may be able to offset your management fees and some other expenses, I have yet to meet anyone who actually pays their whole mortgage through renting. Instead, many drop out of the rental process altogether, citing time, added stress, damages, and wear and tear on their property, with minimal rent to show for it.

You should budget 1-2% of the purchase price per year to spend on repairs and maintenance. Some years you will spend less, but in other years, you may need to replace a roof, furnace, or other major item. Is your emergency fund big enough to cover two homes? There will be days when having two homes feels like you are trying to prove Murphy’s Law – if something can go wrong, it will!

If you want to save yourself the headache of getting that 11 pm call in December that the hot water heater is out, don’t be an absentee owner. Just take vacations. If after five years at the same beach, you decide you’d rather go to Europe next summer, you can change your plans and not feel like you are obligated to go to your second home year after year. In fact, behavioral finance suggests that you may have more memories and find more fulfillment from taking 10 different vacations rather than going to the same place for 10 summers in a row.

3) On taxes and finances, a few points to consider:

You can deduct mortgage interest and property taxes on a second home. These are itemized deductions.
Only your primary residence is eligible for a capital gains exclusion of $250,000 ($500,000 if married). For a second home, keep records of any capital improvements which would increase your cost basis. If you have a very large potential capital gain, you can receive the primary residence capital gains exclusion by making the property your primary residence for two years. As long as a property was your primary residence for two of the past five years, you are eligible. Keep capital gains records until seven years after the sale.
You can rent out a primary or second home for 14 days a year tax-free. You don’t even have to report this income!
If you use the property personally for more than 14 days or more than 10% of the total rental days per year, it is considered a personal residence and you can only deduct rental expenses up to the amount of rental income.
If your personal use of the property is less than 14 days AND less than 10% of the total rental days, the property is considered a rental property (a business), and not a second home. You can deduct losses and may depreciate the property. Note that days you spend full-time on repairs and maintenance (but not improvements) are not considered personal use days, even if the rest of your family is enjoying recreation that day.
If you let others stay for free, or below fair rental price, or give away days (even to a charity auction), those are considered personal use days.
Before you rent, make sure your insurance covers renting. Talk with owners of similar properties if you want a realistic idea of how many days of your property might be rented each season. Do your homework before you buy.
In Texas, primary residences are creditor protected, 1 acre in town or 100 acres rural, with no limit on value. These are doubled for married couples. Second homes are not creditor protected. Which mortgage should you pay off first? Probably your primary residence.

Link: IRS Publication 527, Residential Rental Property Including Rental of Vacation Homes.

If all this makes your head hurt, you may be happier keeping your life simple and just enjoying your vacations without owning a second home. You cannot ask your accountant to sort this all out at the end of the year if you haven’t kept complete records of use/rental days and expenses.

4) When it comes to affordability, don’t let a mortgage broker tell you how much you can afford. They calculate the maximum the bank is willing to lend you; they don’t care about your other priorities like contributing to your 401(k) or paying for your kid’s college. If you want to know what you can afford and still accomplish your other goals, you need to do a financial plan. That’s where I can help.

5) Not surprisingly, the vast majority of people I have met who purchased a timeshare have been frustrated and regretted the decision. Similarly, friends who purchase property together often find things become less than cordial when disagreements arise over use, expenses, or maintenance.

Link: HGTV Top 10 Things to Know About Buying a Second Home

Don’t Forget Your Umbrella!

Posted On August 15, 2016 By Scott Stratton, CFP(R), CFA In Financial Planning / 1 Comment

For successful individuals, an Umbrella Policy is a smart idea and a cost-effective tool to protect your life savings from a liability suit. An Umbrella policy covers you if you exceed the liability coverage limits on your home and auto insurance. For around $200 to $300 a year, you could be covered for another $1 million, and have the option to increase this up to $5 million.

The liability limits on home and auto policies are typically much too low to insulate you from the potential costs you could face today. While the state may only require $50,000 in auto liability, this is not going to cover the cost of hitting a fancy car or worse, if you were to injure or kill people on the road. If the injured person has costs greater than your liability coverage, their next step: sue you. Even if they don’t do it, their insurance company will to recover their damages.

Your first and best line of defense is an Umbrella Policy. If a claim (or lawsuit) were to exceed your liability limits, the umbrella coverage will kick in so that you would not have to pay out of pocket or have a judgement that could take years to pay.

Your liability for vehicle damage would be limited to the value of another vehicle. I recently saw a Porsche 918 on the road, which has a base price of $847,000. There are tons of very expensive cars on the road in Dallas. But vehicle damage is easily quantifiable. What is scarier is injury liability. Besides the fact that hospitalization and surgery can costs tens of thousands of dollars, you could also be held liable for physical therapy, loss of income, and intangibles such as reduction in quality of life or pain and suffering. Is that something you would want to leave in the hands of a sympathetic Jury?

Even if you increase the liability limits on your home and auto policies to the maximum, that may still only be $250,000, $300,000, or $500,000. Attorneys and insurance companies have decades of research and experience in determining who would be worth their time suing. So even though your net worth is not public knowledge, if you have wealth, you are a likely candidate.

I’ve primarily described auto accidents, but you could also be held liable for a visitor who was injured in your pool or hurt anywhere on your property, even if uninvited. An umbrella policy could also cover liability if you have a motorcycle, RV, ATV, or boat. It can protect you from liability for libel, slander or defamation. Umbrella policies cover the same individuals as your home and auto, which is typically your whole household. And it covers them anywhere they go, even if on vacation, or in a rental car.

What does an umbrella policy not cover? It does not cover your personal property, contract disputes, business activities, or intentional / criminal activities. Be very careful about saying you are driving for business, because this could negate coverage under your personal and umbrella policies. These policies cover commuting – driving to your place of work, which is not the same as business travel. This is especially vital if you are self-employed. If you use your home for a business, such as a day care, that would not be covered by an umbrella policy.

We spend years planning and carefully growing your nest egg, all of which could be destroyed in a moment because someone got hurt in your house, or because your teenager was distracted for a moment while driving. It’s not worth risking everything when an umbrella policy only costs a few hundred dollars a year.

To get an umbrella policy, you typically will need to have your home and auto policies with the same insurer and have your liability limits at the highest levels. If this makes your insurance too expensive, consider increasing your deductible, especially if it is just $250 or $500. Instead aim for $1000. When you buy an umbrella policy, this may also be a good time to shop your policies to multiple carriers, as you will likely coordinate your home, auto, and umbrella policies with one company.

This information is for educational purposes only and not a guarantee of benefits. Always read your policy fully to understand your coverage and all exclusions.

Do You Receive Mutual Fund Capital Gains Distributions?

Posted On August 8, 2016 By Scott Stratton, CFP(R), CFA In Portfolio Management /

I always ask prospective clients to bring a copy of their most recent tax return and often learn a wealth of information reviewing their taxes. In doing such a review last week, I noticed that in the previous year, a prospective client had to pay taxes on $13,875 in taxable capital gains distributions from their mutual funds.

If your mutual fund is inside of a 401(k) or IRA, capital gains distributions don’t matter. However, when a mutual fund is held in a taxable account, you end up paying taxes on capital gains distributions even though you didn’t sell the position. Instead, you are paying taxes for trading the fund manager does inside the portfolio, or worse, to provide liquidity to other shareholders, who sold before December and left you holding the bag to pay for their capital gains.

Luckily, there is a better way. In my previous position working with high net worth families, the majority of assets were held in taxable portfolios. We had a number of families with $10 million to over $100 million in investments with our firm. Needless to day, I spent considerable time in looking at ways to reduce taxes, and became very effective at the process of Portfolio Tax Optimization. I offer this same approach and benefits to my clients today.

Vanguard studied the value advisors bring through planning skills like tax optimixation. They estimate that “Advisor’s Alpha” can add as much as 3% a year to your net returns.
Link: Quantifying Vanguard Advisor’s Alpha

If you have significant assets in taxable accounts, I can help you. Here are five ways we can lower your taxes and allow you to keep more of your hard earned principal:

1) Use ETFs. The prospective client with $13,875 in capital gains distributions, had approximately $600,000 in mutual funds. I created a spreadsheet that calculated capital gains if they had been invested $600,000 in my 60/40 portfolio instead. Most of my holdings are Exchange Traded Funds (ETFs), which due to their unique structure, are much more tax efficient than mutual funds. In fact, my nine ETF holdings had total distributions of zero in the same year .

In the 60/40 model, we also had five mutual funds in categories where there are not equivalent ETFs. My calculation of capital gains distributions: $2,167. So, if we had been investing for this client, their capital gains distributions could have been reduced from approximately $14,000 to $2,000. The investment vehicles we choose matter!

I should note that this is just looking at capital gains distributions. Both ETFs and mutual funds also pay interest and dividends, which are taxable. There is more to managing taxes than just picking ETFs.

2) Asset Location. We could have further reduced taxes by choosing where to place each holding. Some funds generate interest, which is taxed as ordinary income, where as other funds generate qualified dividends, which is taxed at a lower rate of 15-20%. We place the funds with the greatest tax liability into your IRA or other qualified account, to reduce your overall tax burden. Funds that have little or no distributions are ideal for taxable accounts.

3) Avoid short-term capital gains. If you sell an investment within a year, those short-term gains are taxed as ordinary income, your highest tax rate. After 12 months, sales are treated as long-term capital gains, at a lower rate of 15-20%. We do not sell or rebalance funds before one year to avoid short-term gains. Unfortunately, many mutual fund managers don’t have any such tax mandate, so oftentimes, a significant portion of fund’s capital gains distributions are short-term.

4) Tax Loss Harvesting. At the end of each year, we review taxable portfolios for positions which have declined. We harvest those losses and immediately replace each position with a different fund in the same category (large cap, international, etc.). This fund swap allows us to use those losses to offset other gains or income, while maintaining our target asset allocation. If realized losses exceed gains, you can use $3,000 of losses to reduce ordinary income. Remaining losses are carried forward to future years.

5) Municipal Bonds. For investors in a higher tax bracket, your after-tax return may be better on tax-free municipal bonds than on taxable bond funds. However, an advisor will not know this without looking at your tax return and determining your tax bracket. That’s why we make planning our first priority, before making any investment recommendations. (Would you really trust anyone making investment recommendations without knowing your full situation? Are those recommendations designed to profit them or you?)

We take a disciplined approach to managing portfolios to minimize taxes, and it is a valuable benefit to be able to customize our approach for each individual client.

On this same client’s tax return, I realized that they did not deduct their Investment Management fees, a $6,000 miscellaneous deduction.
Link: Are Investment Advisory Fees Tax Deductible?

If you have taxable investments, we may be able to save you thousands, too. Let’s schedule a call today. You deserve a more sophisticated and efficient approach to managing your wealth.

How Much Will it Cost to Send Your Kids to College?

Posted On August 1, 2016 By Scott Stratton, CFP(R), CFA In College Savings /

I am in favor of college students “having some skin in the game” in sharing in the cost of their education, but many graduates are leaving colleges with crippling student debt today. For parents and grandparents, it’s never too early to start saving for this investment in your child’s future. As part of my education planning for clients, I use specific colleges to estimate how much a future college education may cost and to suggest how much to save monthly. Ready for some sticker shock?

Example 1: Max is 6 years old and his parents hope he will attend their alma mater, Texas A&M. Today, in-state costs (tuition, room/board, books and fees) are $19,702. The projected costs when Max goes to school will be $117,520 for four years. To save this amount, invest $454 a month, starting immediately.

Example 2: Carla is 3 years old and her parents would like for her to be able to attend a private university, such as Southern Methodist University. Today’s annual cost is $61,385. Projected future expense: $400,105. Invest $1,164 a month.

Assumptions

Student attends college for 4 years at age 18. Of course, many take more than four years, especially if they change majors or decide to pursue graduate studies.
These calculations assume 3% inflation. In recent decades, college costs have increased by 5-6%. Hopefully, these increases will moderate as overall inflation is currently quite low.
We are assuming a 6% rate of return on the investments, and tax-free withdrawals from a 529 Plan. Although this is a fairly conservative assumption, it is, of course, not guaranteed.

We can adjust these assumptions, which will change the estimated costs and savings requirements. The calculator gives us a ballpark idea of just how significant an expense it is to send a child to college today, let alone two or three kids. Typically, we run a couple of scenarios to give a range of possible costs for parents.

A 529 College Savings Plan is a great tool for this job. Withdrawals from a 529 are tax-free when used for qualified higher educational expenses. There is no expiration on funds in a 529 and the account owner can change the beneficiary of the account, if one child does not need all the funds. The biggest benefit of a 529 is the tax-free growth, which means that we want to start a 529 as soon as possible for a child to receive many years of compounding. Once they’re 16 or 17, it’s too late to receive much of a tax benefit.

Link: 8 Questions Grandparents Ask About 529 Plans

Want to estimate how much it will cost for your child or grandchild to get the same college education you received, or wish you had received? Send me the details and I’ll get back to you with an estimate. If you’re ready to add college savings to your overall financial plan, I am here to help!

Do You Hate Saving Money?

Posted On July 25, 2016 By Scott Stratton, CFP(R), CFA In Behavioral Finance / 1 Comment

Take your medicine. Make some sacrifices. Prepare for a rainy day. Tighten your belt.

Does this describe how you feel about saving and investing? Is it some sort of cruel punishment? Do you begrudgingly invest just enough dollars to get the company match and say that you “have a 401k”? You’re not alone. A lot of Americans feel the same. We are a nation of spenders, not savers.

The US household savings rate was 5.057% for 2015, according to the latest data from the Organization for Economic Development and Co-operation. Compare this to other developed countries: 8.563% in Australia, 9.668% for Germany, or 20.130% for Switzerland. The savings rate is estimated to be over 25% in China.

While the “average” household savings rate is 5.057% in the US, that average consists of a small number of people who save a significant amount of their income, and the majority of Americans who are living from paycheck to paycheck and save exactly zero. According to one study, 62% of Americans don’t have the ability to cover an unexpected $500 bill today.

I wish I could change people’s attitudes about savings. For some, saving money means buying an $80 sweater when it’s on sale for $40. But that is still spending money, not saving! Saving is setting money aside and having it grow. When you view saving as a negative – a chore that keeps you from having fun – your attitude may be the biggest roadblock to your own prosperity.

Saving and investing is the path to financial independence. Even if you don’t want to retire, we should still aim for financial independence, so you can work because you want to and not because you have to. Saving isn’t just for retirement planning, it’s developing a plan for financial security to free you from worry.

How can we make saving easier? What steps make you more likely to succeed?

1) Put your saving on autopilot through automatic monthly contributions. Whether it is establishing an emergency fund, contributing to a 401(k) or IRA, or creating a 529 college savings plan, making it automatic is the way to go.

2) Set goals. If you don’t have a finish line – a target amount for your nest egg – it’s hard to feel any sense of urgency to saving. When I was 30, I knew where I wanted to be at 50, which also meant I could determine where I needed to be at 35, 40, and 45. Those specific goals have helped me stay on track through the years. Without long-term goals, short-term actions often lack direction and a clear purpose.

3) Think big, not small. How many times have you read that you can fund your IRA by giving up your daily coffee fix. Forget that! If you get the big decisions right, the small stuff takes care of itself. Instead, be very smart, calculating, and objective on just two things: housing and cars. Those are the biggest expenses for almost everyone, and we have tremendous discretion in choosing how much we spend on these two categories.

If you want to jump start your saving, take a close look at all your recurring monthly costs: insurance, utilities, cell phone, cable TV, and memberships. Comparison shop, look for savings, and drop items you don’t use or won’t miss.

4) Focus on maximum saving. There is an oft-repeated rule of thumb that you should save 10% of your income. I am guilty of saying this one, too, especially as a “realistic” goal for new savers. However, there is nothing magical about the number 10%, and there is no guarantee that if you start saving 10% today that you will have enough money to accomplish all your financial goals. Instead, try to contribute the maximum to your 401(k): $18,000 or $24,000 if over age 50. And if you are also eligible for an IRA, fund a Traditional, Roth, or Backdoor Roth IRA. If you have self-employment or 1099 income, you may also be eligible for a SEP-IRA.

If it helps you to increase your saving, then let’s calculate each need separately and contribute to:
– Employer retirement accounts
– IRAs
– Health Savings Accounts
– 529 College Savings Plans
– Term life insurance policy
– Taxable brokerage account
– Savings for a first or second home down payment

Regardless of whether the market is up or down in 2016, I will have done my part by funding my accounts and accumulating more shares of my funds and ETFs. Over time, the returns will average out, but I accept that I have absolutely zero control over what the market does this year. What I do have control over is how much I save, and that’s more important.

I know a lot of millionaires who were great savers and invested in generic, plain mutual funds. But I have yet to meet anyone who has turned $5,000 into a million through their brilliant investing. Investing decisions matter, but you are likely to reach your goals faster if you can figure out how to save 50% more rather than spending your time trying to increase your returns by 50%, because it is not possible over any meaningful measure of time.

I feel great about saving and you should, too. It is empowering to see planning pay off when you have been diligent and consistent about saving. There is a lot of uncertainty and fear right now, and even as the market makes new highs, investors are very wary. If you want to become wealthy, divorce your feelings about today’s market from your feelings about saving. If you’re serious about getting to your goals sooner than planned, save more today!

Is Your Car Eligible for a $7,500 Tax Credit?

Posted On July 18, 2016 By Scott Stratton, CFP(R), CFA In Financial Planning /

If you are in the market for a new vehicle, you may want to know about a tax credit available for the purchase an electric or plug-in hybrid vehicle. Worth up to $7,500, the credit is not a tax deduction from your income, but a dollar for dollar reduction in your federal income tax liability. In other words, if your tax bill was $19,000 and you have a $7,500 credit, you will pay only $11,500 and get the rest back.

This credit has been available since 2010, but in the last two years a significant number of new car models have become eligible for the tax credit. If you drive a lot of miles, these cars may be worth a look.

The credit includes 100% electric vehicles like the Tesla Model S or the Nissan Leaf, and it applies to the newer plug-in hybrid models, including the BMW i3, Chevrolet Volt, Ford C-Max Energi, Hyundai Sonata Plug-In Hybrid, and others. The credit does not apply to all hybrid vehicles, only those with plug-in technology. While the plug-in cars may be more expensive than regular hybrids, they are often less expensive once you factor in the tax credit.

The amount of the credit varies depending on the battery in the car, and may be less than $7,500. The credit is phased out for each manufacturer after they hit 200,000 eligible vehicles sold, with the credit falling to 50% and then to 25%. So, for those 400,000 people who put down a deposit on the Tesla Model 3, most will not be getting the full $7,500 tax credit. Only purchases of new vehicles – not used – are eligible for the credit.

The program is under Internal Revenue Code 30D; you can find full information on the IRS website here. An easier-to-read primer on the program is available at www.fueleconomy.gov.

Some states also offer tax credits or vouchers for the purchase of a plug-in hybrid or electric vehicle. Unfortunately, Texas is not one of those states! You can search for your state’s programs on the US Department of Energy website, the Alternative Fuels Data Center.

Do you have a plug-in hybrid or electric vehicle? Send me a note and tell me how you like it.