9 Ways to Manage Capital Gains

Investors want to rebalance or reduce their exposure to stocks without creating a large tax bill. We specialize in tax-efficient portfolio management and can help you minimize the taxes you will pay. Here are 9 ways to manage your investment taxes more effectively:

1. Use ETFs instead of Mutual Funds. ETFs typically have very little, and often zero, capital gains distributions. Actively managed mutual funds are presently sitting on very large embedded gains, which will be distributed on to shareholders as the managers trade those positions. Using ETFs gives you better control of when you choose to realize gains.

2. Donate appreciated securities to charity instead of cash. If you are already planning to give money to a charity, instead donate shares of a stock or fund which has appreciated. The charity will get the same amount of money and they will pay no capital gains on the sale. You will still get the same tax deduction (if you exceed the now higher standard deduction) plus you will avoid paying capital gains. Use the cash you were planning to donate to replenish your investment account. Same donation, lower taxes.

Consider funding a Donor Advised Fund and contributing enough for several years of charitable giving. If you give to a large number of charities, it may be easier to make one transfer of securities each year to the Donor Advised Fund, and then give to the charities from the Fund.

3. Give appreciated securities to kids in the zero percent capital gains bracket. Some taxpayers in the lower brackets actually pay a 0% capital gains rate. If your grown children are no longer dependents, and would qualify, they may be able to receive the shares and sell them tax-free. Just be sure to stay under the $15,000 annual gift tax exclusion per person. For 2018, the zero percent capital gains rate will apply to single taxpayers under $38,600 in income and married couples under $77,200.

4. Harvest losses annually. Those losses give you the opportunity to offset gains and rebalance your portfolio. Any unused losses will carry forward to future years without expiration. And you can also use $3,000 a year of losses to offset your ordinary income, which means that instead of just saving 15-20% in taxes you could be saving 37% or more.

5. Develop a Capital Gains Budget. It’s not all or nothing – you don’t have to sell 100% of a position. We can trim a little each year and stay within an annual capital gains target. We also can sell specific lots, meaning we can reduce a position and choose to sell shares with the highest or lowest cost basis.

6. Wait a year for long-term treatment. We try to avoid creating gains under 12 months. The long-term rate is 15% or 20%, but short-term gains are taxed as ordinary income.

7. Use your IRA. If you have a well diversified IRA, we can often rebalance in that account and not create a taxable event. While many investors put taxable bonds in IRAs and leave the equities in a taxable account, for taxpayers in a high bracket, you may prefer to buy tax-free municipal bonds in the taxable account and keep equities in the IRA.

8. Stop Reinvesting Distributions. If your position in a stock or fund has grown, don’t make it larger through reinvestment of dividends and distributions! Reinvesting takes away your choice of how to rebalance your portfolio with the cash flow you receive. However, please make sure you are doing something with your distributions in a timely manner and not letting them accumulate in cash.

9. Just take the Gains already! Don’t let a gain disappear because you don’t want to pay 15% in taxes. If you have a big winner, especially with an individual stock or a speculative investment like bitcoin, take your gains and move on. If we become too obsessed with taxes we run the risk of letting our investment returns suffer.

While most people are thinking about their 2017 taxes right now, reacting to what has already passed, we suggest looking ahead to 2018 and being proactive about managing your futuretax liabilities. Taxes can be a significant drag on performance. If you’re investing in a taxable account, we can give you peace of mind that you have a plan not only for financial security, but also to manage your capital gains as efficiently as possible.

What Are Quarterly Tax Payments?

The IRS requires that tax payers make timely tax payments, which for many self-employed people means having to make quarterly estimated tax payments throughout the year. Otherwise, you could be subject to penalties for the underpayment of taxes, even if you pay the whole sum in April. The rules for underpayment apply to all taxpayers, but if you are a W-2 employee, you could just adjust your payroll withholding and not need to make quarterly payments.

If your tax liability is more than $1,000 for the year, the IRS will consider you to have underpaid if the taxes withheld during the year are less than the smaller of:

1. 90% of your total taxes dues (including self-employment taxes, capital gains, etc.)
2. 100% of the previous year’s taxes paid.

However, for high income earners – those making over $150,000 (or $75,000 if married filing separately) – the threshold for #2 is 110% of the previous year’s taxes. Additionally, the IRS considers this on a quarterly basis: 22.5% per quarter for #1, and 25% per quarter for #2, or 27.5% if your income exceeds $150,000.

Many taxpayers will find it sufficient to make four equal payments throughout the year. If that’s the case, your deadlines are generally April 15, June 15, September 15, and January 15. However, if your income varies substantially from quarter to quarter, or if your actual income ends up being lower than the previous year, you may want to adjust your quarterly estimated payments to reflect these changes.

You can estimate your quarterly tax payments using IRS form 1040-ES. Of course, your CPA or tax software should automatically be letting you know if you need to make estimated tax payments for the following year. You can mail in a check each quarter, or you may find it more convenient to make the payment electronically, via IRS.gov/payments.  For full information on quarterly estimated payments, see IRS Publication 505 Tax Withholding and Estimated Tax.

Please note that the estimated payments will fulfill the requirement of 100% of last years payment, or 90% of this year’s payment if that figure is lower. However, it is not required that you pay 100% of the current tax bill, so if your income is significantly higher this year, you could still owe a lot of taxes in April even after making quarterly estimated payments.

If you’re self-employed, you don’t need to be a tax expert, but you do need to understand some basics and to make sure you are getting correct advice. When you aren’t being paid as a W-2 employee, it is up to you to make sure you are setting money aside and making those tax payments throughout the year, so that next April you aren’t facing penalties on top of having a large, unexpected tax bill.

When To Get Out Of Equities

Look at each time the S&P 500 Index fell by 8% since 1928, and you will find two very different types of outcomes. 85% of the time, an 8% drop resulted in only a shallow correction, an average of 13%, which the market recovered from, on average, in just 106 days. That’s tolerable.

However, in 15% of the 8% drops, the stock market was headed into a severe Bear Market, suffering an average decline of 43%, which took 1090 days to recover.* That’s three years – from the bottom – just to get back to even. Anyone who invested through the Tech Bubble in 2000-2001 and the Crash of 2008-2009 needs no reminder that Bear markets have always been a part of investing.

Given a choice, wouldn’t you rather be on the sidelines when things are falling apart? Investors of all ages feel this way, but for those who are closer to retirement, we don’t have the luxury of saying, “Well, I can just Dollar Cost Average since I don’t need to touch this money for 30 years”.

Most sources say you cannot time the market. That’s because people usually base their decisions on sentiment and worthless forecasts. We are blind to our own confirmation bias, where we look for opinions that support our prejudices, rather than looking objectively at all evidence.

Without a crystal ball, how can you tell when a small drop is just a brief correction versus the first weeks of a longer Bear Market?

To remove human emotion and look solely at the price movement of the market is the objective of Technical Analysis. Let’s consider a chart of the historical prices of the S&P 500 Index. One of the ways to examine the larger trend of market is through a Moving Average (MA). This is simply a measure of the average price over a number of days, such as 20, 60, 120, or 200 days. A Moving Average with small number of days responds quickly to changes in market prices, whereas a MA based on a large number of days is smoother and slower to react.

When the market is boldly moving up (like in 2017), a chart will have these characteristics:

  • The 60-day moving average is above the 120-day moving average, and both have an upwards slope, gaining each day.
  • The current price of the market is above the moving averages, pulling the averages higher.

When we are in a prolonged decline (like in 2008), a chart will typically have the reverse characteristics:

  • The 60-day moving average is below the 120-day moving average, and both have a downwards slope, sinking each day.
  • The current price of the market is below the moving averages, pulling the averages lower.

A brief drop, like we experienced in February, is a temporary blip in the market price and has little impact on the longer 60 or 120 day moving averages. Technical Analysis suggests that a Bear Market may be starting when there is a crossover – when the 60-day MA goes from being above the 120-day MA to being below it.

Crossovers are considered a major shift in the direction of the market, and often do not occur for years at a time. Crossovers occurred relatively early in the previous two Bear Markets and if you had used that signal to sell, you would have significantly reduced your losses. The reverse crossover, when the 60-day breaks above the 120-day MA, is considered a Bullish indicator that the downwards trend has broken. That’s the Buy signal to get back into the market.

A few caveats are in order: these signals will not pinpoint the top or bottom of the market. With a 60-day lag, the market could have already have suffered significant losses before we get a “Sell” signal. Similarly, at the bottom, the market could have rebounded by a substantial percentage before we get the “Buy” signal to get back in. In a shorter Bear Market, these indicators might have you get out at a loss and then buy back in at a higher level, adding insult to injury.

Looking at back-tested funds which use this approach, however, they would have had lower losses in the past two Bear Markets. While it’s nice to avoid the losses, what is even more compelling is how well the strategy performs over 10 or more years. After studying this for nearly two years, we are now going to offer this strategy to our clients, calling it the Equity Circuit Breaker.

This does not change what we purchase in our portfolios. Investors will have the choice of adding the Equity Circuit Breaker or not. If you want to participate, we will track these moving averages and when a crossover occurs, we will sell your equity positions and move the proceeds into cash or short-term Treasuries. When the Bullish crossover occurs, we will buy back into your equity funds, returning to your target asset allocation.

The goal is to reduce losses then next time we have a Bear Market. While there is no guarantee this program will work exactly as it has in the past, you might prefer to have a defensive strategy in place versus the alternative of staying invested for the whole ride down and back up.

I am making this optional for two reasons. First, some investors have a long enough time frame to accept market volatility and prefer a simpler approach. Second, taxes. Selling your equity positions in a taxable account could generate capital gains.

But let’s take a closer look at the tax question. Let’s say you have a 50% gain in your equity positions. You started at $200,000 and it has grown to $300,000. If we were to sell those positions and create $100,000 in long-term capital gains, you’d be looking at 15% tax, or $15,000. (Long-Term Capital Gains could be as high as 23.8% for those in the top tax bracket.) That is a substantial amount of tax, but could still be worth it. If we avoid a 20% drop, you would have prevented $60,000 of losses.

Paying some taxes along the way also will increase your cost basis and basically just pre-pay taxes you would otherwise pay later. For example, Investor A buys a fund for $10,000, sells it at $15,000 after year two and generates a $5,000 capital gain. Then she buys back into the fund with the $15,000 and sells it at $18,000 at year five, for a $3,000 gain. Investor B buys a fund for $10,000, holds it for the same five years, and then sells for $18,000. Both investors will pay the same tax on $8,000 in capital gains. Investor A just split that tax into two segments whereas Investor B paid the tax all at the end.

Of course, if your accounts are IRAs, we could trade without any tax consequences. If you’d like to add the Equity Circuit Breaker to your Good Life Wealth Management Portfolio, there is no additional cost, just reply to this email. We also offer the option of limiting the Equity Circuit Breaker to your IRAs and not to your taxable accounts. I’ll be talking with clients individually throughout the Spring about the new program.

As of today, we have not had a crossover, so there is not yet a trigger for us to sell. I will be looking at this on a regular basis. Investors should make the decision about participating well in advance of the trigger occurring. Once the losses have already started, it is harder to make a decision. I think the best use of this approach is passive – to consider it carefully in advance, turn it on (or not), and then leave it alone. We will do the work for you.

If today’s market is making you nervous, the Equity Circuit Breaker may help you sleep better at night. You have been telling us “we want to participate in the upside, but want to step aside when things get ugly.” If that’s what you’ve been thinking, feeling, or wishing, we can provide you with a plan that’s based on a disciplined process.

*Market Pulse, Goldman Sachs Asset Management, February 2018

Vanguard’s Measure of Our Value

We create value for you through holistic financial planning, looking at your entire financial picture to create a comprehensive approach to investing your money, gaining financial independence, and safeguarding you from risks. This sounds great, but let’s face it, it’s pretty vague. The numerical benefits of hiring a financial advisor can be difficult to evaluate. Since 2001, Vanguard has spent considerable resources in measuring how I can add value for investors like you.

Their study is called Vanguard Advisor’s Alpha and they have identified areas where financial advisors create tangible value. Their aim is to quantify how much a client might benefit from each process a financial advisor could offer. Vanguard’s conclusion is that an advisor like me can add 3% a year in benefits through effective Portfolio Construction, Behavioral Coaching, and Wealth Management.

Their recommended approach in these areas very much reflects what I do for each client. Not all advisors use these steps with their clients. If your advisor isn’t talking about these actions, you could be missing out. Vanguard has analyzed how much a client might gain from each step in our financial planning process. Benefits, below, are measured in basis points (bps), where 1 bp equals 0.01% in annual benefits.

1. Portfolio Construction

  • Suitable Asset Allocation / Diversification >0 bps
  • Cost Savings (Expense Ratios) 40 bps
  • Annual Rebalancing 35 bps

Our approach is to create long-term, diversified investment strategies for each client. We start with a top-down asset allocation and use ultra low-cost ETFs and institutional-class mutual funds to implement our allocation. Portfolios are rebalanced annually.

2. Behavioral Coaching

  • Estimated Benefit 150 bps

There is a huge benefit to coaching and that’s why we prefer to write about behavioral finance topics than giving you “weekly market updates”. You can’t control what the market does, but you can control how you respond. And how you respond ends up being one of the biggest determinants of your long-term results.

We take the time to create a solid plan, educate you on our approach, and reinforce the importance of sticking with the plan. There are real risks to having a knee-jerk reaction to a bear market, chasing performance, or buying into bitcoin or whatever fad is currently making the headlines. Based on Vanguard’s calculations, the value of Behavioral Coaching is actually greater than investing steps like asset location or rebalancing.

3. Wealth Management

  • Asset Location 0 to 75 bps
  • Spending Strategies (withdrawal order) 0 to 110 bps
  • Total Return versus income approach >0 bps

Asset location is creating tax savings by placing certain investments in retirement accounts and certain investments in taxable accounts. Spending Strategies, for retirement typically, are another area of considerable attention here at Good Life Wealth. Go to our Blog and you can find all of our past articles (currently 197). In the upper right, use the Search bar and you can find several articles explaining these concepts and how we implement them.

Vanguard lists some of these benefits as 0 bps with the explanation that the value can be “significant” but is too individual to quantify accurately. When they do add up the benefits we can achieve in Portfolio Management, Behavioral Coaching, and Wealth Management, Vanguard believes we are adding 3% a year in potential benefits for many clients.

We hope this may help those who are on the fence, wondering if it is worth it to hire us as your financial advisor. There is a value to what we offer or I wouldn’t be in this profession. The Vanguard study doesn’t consider our benefits in helping you with tax planning, risk management, estate planning, college funding, or other areas. They also don’t consider intangible benefits, such as peace of mind, saving time by hiring an expert versus trying to do it yourself, or the fact that investors who create a retirement plan with an advisor save 50% more than those who do not.

We offer two distinct programs to meet you where you are today and help you get to where you want to be. We are welcoming new clients for 2018. Do you have questions about how we might add value for you? Let’s talk.

Premiere Wealth Management
Comprehensive financial planning and portfolio management
Cost is 1% annually, for clients with $250,000 or more to invest

Wealth Builder Program
Subscription program to build your net worth with expert financial planning in the areas you need
Cost is $99/month, for clients with $0 to $249,999

Roth Conversions Under the New Tax Law

The Tax Cuts and Jobs Act (TCJA) will impact Roth Conversions in 2018 and beyond in a number of significant ways for investors. Since I can hear the yawns already through my laptop, here’s why you should care: wouldn’t it be great to have your investment account growing tax-free? Once you are retired, which would you prefer: an account with $100,000 which you could access tax-free or one which will cost you $22,000 or more in taxes to use  your money? Taxes can take a huge bite out of your investment returns.

Quick refresher: A Roth IRA holds after-tax money and grows tax-free. A Conversion is when you take a Traditional IRA, 401(k), or similar account, pay the taxes on it today, and transfer it to your Roth IRA. While that does mean paying taxes now, any future growth in the account would be tax-free. When you withdraw the money from a Roth IRA in retirement, you pay no taxes.

The TCJA has both positive and negative impacts on doing a Roth Conversion:

1. Lower tax rates. Under the TCJA, most people will receive a 1-4% reduction in their marginal tax bracket. For example, the top bracket was 39.6% in 2017 and will be 37% in 2018. If you are in the top bracket, a Roth Conversion is cheaper by 2.6% today.

For a married couple, if your taxable income is under $77,400 you are now in the 12% tax bracket. Paying 12% to convert an IRA to a Roth would be a bargain, but the Conversion plus your taxable income would need to stay under $77,400 to remain in the 12% rate. With a $24,000 standard deduction, a married couple could make as much as $101,400 and be in the 12% bracket.

To add a sense of urgency, don’t forget that the new lower tax rates are only temporary. In 2026, the top rate goes back to 39.6%. I suppose Congress could extend the tax cuts, but no one knows what will happen in eight years. What we do know is that deficits will rise dramatically, which suggests to me the need to have higher taxes in the future.

2. Beneficiary’s Tax Rate. If your beneficiaries – children, grandchildren, or anyone – are in higher tax bracket than you, the tax bill may be lower for you to convert your IRA to a Roth than for the beneficiaries to inherit the IRA. With a Conversion, your heirs inherit your Roth IRA tax-free. Also, converting to a Roth means you do not have to pay any Required Minimum Distributions (RMDs) starting at age 70 1/2, allowing your account to grow.

If you were planning to leave your Traditional IRA, perhaps in trust, to your young grandchildren, the TCJA will change how they are taxed. For children under age 18, or under age 24 if full-time students, they used to be taxed at their parent’s tax rate. Now for 2018, the “Kiddie Tax” will increase the tax on unearned income, such as IRA distributions, to the much worse tax rate of trusts, a 37% tax rate on income above $12,500.

3. The TCJA eliminated Recharacterizations. Previously, you could undo a Roth Conversion through a process called a Recharacterization. Why would you want to do that? Let’s say you converted $10,000 of a mutual fund from a Traditional to a Roth IRA in January; you would pay taxes on the $10,000 as income. Now, imagine that the account went down and was worth only $8,000 by November. You’d be pretty mad to pay taxes on $10,000 when your account was then only worth $8,000.

The Recharacterization would let you cancel your Roth Conversion if you didn’t like the outcome within that tax year. You could get a “Do-Over”. The TCJA eliminated Recharacterizations, so now if you do a Roth Conversion, you are stuck with it!

4. Back-Door Roth. Since 2010, there has been a type of Roth Conversion called a Back-Door Roth IRA. It allows high income investors who did not have any IRAs to fund a non-deductible Traditional IRA and then convert it to a Roth. It was a “Back Door” way to fund a Roth IRA if you made too much to qualify under the regular rules. There was discussion in Congress to eliminate the Back Door Roth IRA (as there has been for years), but in the final version of the TCJA, it is still allowed…for now.

So, should you convert your IRA to a Roth? If you are in a low tax bracket, 10% or 12% in 2018, I think it is worth consideration. If you are in a low tax bracket this year and anticipate your income rising substantially in future years, this would be a good year for a Conversion. You don’t have to convert your entire IRA. You could just convert a portion that would stay within your existing tax bracket. I suggest you use outside funds to pay the taxes, rather than the proceeds of the conversion.

If you are planning to leave your IRA to a charity, they can receive the funds without paying any income taxes and you should not do a Roth Conversion. In fact, if your estate plan includes donations to charity, the most tax-efficient solution is to make those donations from your Traditional IRA. Instead, leave your heirs money from taxable investment accounts; they can receive a step-up in cost basis and potentially owe little or no income taxes or capital gains.

If your IRA is invested in equities, converting when the market is at an all-time high is a risk. With the elimination of Recharacterizations, you don’t get a do-over if the stock market tanks after you do a conversion. It would be preferable to do a conversion is when your account is at a low point, such as in a Bear Market. Educate yourself now, and then in the future, if the market does go down by 25% or 30%, that would be an advantageous time to convert your investments to a tax-free Roth to enjoy the likely subsequent rebound.

In the mean time, if you have questions about Roth Conversions, or just choosing a Roth versus Traditional account for your 401(k), please send me a note. A Roth Conversion could possibly save you tens of thousands of dollars in retirement, which would definitely help elevate your lifestyle. It’s a big decision – often costing thousands of dollars in taxes today – so we have to make sure we are making a well-informed choice and have a thorough understanding of the costs and benefits.

Putting February in Perspective

2017 was not only a great year in the market, but an anomaly of historic proportions for its extremely low volatility. There were no large daily swings in 2017, and no big drops or corrections regardless of the economic data, corporate earnings, or political turmoil. The market never fell below the January 1st level in 2017, so the year-to-date numbers were positive for the entire year.

This January continued 2017’s winning streak, but February was another story altogether. The market plunged roughly 10% in a week, including the largest single day point drop in the history of the Dow Jones Industrial Average. The market regained much of its loss, but has sold off by 3% or so in the past week. Investors are wondering is whether this is the end of the bull market and what to do next.

Here is the frustrating reality about being an investor: No one can predict the future. Forget about Wall Street forecasts – their track record of accuracy is horrible. The market doesn’t care what we think, positive or negative. The old saying that “the market climbs a wall of worry” has certainly been true the past year or two.

If you would have asked me at the start of 2017 if I thought the S&P 500 Index would go up 22% that year, I would have said no way. The prices were relatively high, we faced rising interest rates, and the political climate was a mess. Uncertainty is not supposed to be the backdrop for a 20%+ year.

Thankfully, I did not act on my opinions in January of 2017 and get out of the market, because we would have missed a tremendous year of investment returns. We should recognize that even when we think our feelings about the market are based on a rational examination of facts, there is no guarantee that the outcome will be as we expect. We are too easily influenced by recent performance and allow our fear or greed to drive investment decisions about what should be a decades-long plan.

For those who are disturbed by February’s action, I’d suggest taking a 30,000 foot view. Although the market did correct by 10%, we basically only gave up the gains from a few weeks and put accounts back at the level they were in December. The market pulled back towards the 200-day moving average, a key level of support, but did not cross or violate those levels. In other words, the overall trend upwards has not been broken. Perhaps the market just needed a correction and chance for profit-taking. That’s healthy and not necessarily a bad thing.

The US economy looks strong, and while the stock market could diverge from the economy, I think we can take comfort in knowing that wages are rising, unemployment is very low, earnings are growing, and many companies are robust and profitable. The tax cuts going to corporate America will increase earnings. Although we’ve gone nine years without a bear market, we are in unprecedented times, so it is possible that the market continues up for a while longer.

I share this not because I think my job is to be bullish or to convince people to buy stocks. Rather my objective is to educate investors, moderate our behavior, and encourage consistency. When fear starts to pick up, that’s the time when it becomes challenging to stick to the plan. Our focus should be on looking out 10 or 20 years. That’s the sort of time frame we really need to have in mind as an investor.

Just like the seasons, there will be a bear market – a drop of 20% or more – in the future. But investors would be better served by worrying less about the inevitability of market cycles and instead focusing on what they can control: how much they save, diversifying, keeping costs and taxes to a minimum, and having a long-term strategy.

We will continue to watch the market closely and evaluate whether a temporary correction threatens to become a more prolonged decline. If that were to occur, we would take action. For some investors, we may choose to become more defensive. For those with a longer time horizon, I think you want to buy when the market is on sale. This decision would be based on technical indicators – what the actual price movement of the stock market suggests – rather than a decision influenced by news, market sentiment, forecasts, or opinions. (We will explore this topic in more detail in an upcoming post.)

Presently, there is little from February to indicate that we’ve had anything more than a garden variety correction. Volatility is a normal part of investing, something we need to remind ourselves after 2017. If you’re not currently investing with us, let’s talk about how you are currently positioned and see if we might be able to recommend some ways to improve your investment strategy.

Car Subscriptions

The question used to be “Should I buy or lease a car?”, but there’s a new alternative, a Car Subscription. It’s intriguing and I am curious to see where this goes five years from now. Maybe you are hearing about it here for the first time.

A car subscription is all-inclusive: for one monthly price, you get the vehicle, maintenance, registration, roadside assistance, AND insurance. You should have no other cost than gasoline. These car subscriptions are brand new and being tested by major manufacturers including Ford, Volvo, Cadillac, and Porsche. Right now, subscriptions seem to be targeted at opposite ends of the market: luxury vehicles for the very wealthy and more entry level vehicles for younger adults.

At the high end, Cadillac offers Book, which will deliver a new Cadillac of your choice to your door. Get bored with an Escalade? Log in to the Book app and swap it for a CTS-V or one of five Cadillac vehicles. You can change vehicles 18 times a year. The program’s monthly cost is $1,800 and it includes 2,000 miles a month. Presently, Book available only in NYC, Los Angeles, and right here in Dallas.

Porsche’s subscription service, Passport, offers your choice of different vehicles for $2,000/month or $3,000/month, currently limited to the Atlanta area. Porsche’s service has unlimited miles and unlimited switches between models. Weather’s going to be nice, order a convertible. Taking a road trip? Swap for an SUV.

The Porsche and Cadillac deals might appeal to people who are very wealthy and aren’t price conscious. I’m sure some companies will offer this as an executive bonus. Other subscribers may have a temporary need for a few months and may find a subscription appealing for its flexibility with being able to switch from a sports car to a sedan or SUV. But for most drivers, it isn’t a very economical alternative to owning a vehicle.

There are two other programs which might be more suited to the average driver, especially if you are paying a lot for car insurance. Here in Dallas, it seems like everyone pays several hundred dollars a month in car insurance, and possibly more, if you have a younger driver in your household, or have some tickets or claims in your recent driving history. In a subscription, the insurance is already included and doesn’t change based on your individual background.

Care by Volvo is the first nationwide subscription program, and will be available for their new XC40 crossover this spring. Both the car and the subscription are targeted at Millennials, but I think will have appeal to many others. The subscription is $600 a month, but if that saves you $200 a month in insurance, that would be similar to a $400 lease, except there’s no down payment. Is the insurance any good? Yes. It’s Liberty Mutual, with $500,000 in liability coverage, and a $500 deductible for collision and comprehensive.

Volvo’s subscription is a 24 month commitment, with 15,000 miles a year included. You can get a new car after 12 months, by restarting the 24 month clock. This program is more like a traditional lease, with the inclusion of insurance and all maintenance and repairs.

Ford subsidiary Canvas offers used vehicles in their subscription program, presently available only in Los Angeles and San Francisco. These are 2-3 year old lease returns, and are offered for $375-$575 a month for a Fiesta, Fusion, Escape, Explorer, Mustang, or F-150. The monthly base price includes 500 miles, or you can upgrade to 850 miles for $30, 1250 miles for $60, or unlimited monthly miles for $90. This is a month to month subscription, with no long-term commitment. You can change cars every month if you want, but if you keep one vehicle, they lower your base price each month.

A subscription might be an opportunity for someone who has very high insurance costs to lower their total costs. The unlimited miles subscriptions, could be an alternative to leasing or buying for the road warriors out there who rack up a lot of miles. For a family that needs a second or third car for just a month or two, a short term subscription might be an alternative to keeping an extra car all year around. While some car subscriptions are targeted towards the very wealthy, other plans will appeal to people with a low credit score who might otherwise have difficulty getting credit to buy a car.

Would I recommend this? The reality is that all vehicles depreciate very quickly when new, so your most cost-effective choice will always be to keep your existing car and drive it for 200,000 miles. But many of us don’t want to keep one car for 10+ years and carry the risk of having to pay for unexpected and expensive repairs, even though these costs are likely to be low when considered over the life of the vehicle. Some drivers will prefer to have a fixed monthly cost for their transportation, rather than tying up $40,000 or more in one car. And that’s why I think Subscriptions are going to be popular, they’re a good match for our innate preferences for flexibility and predictable costs.

Are you considering a car subscription? I’d love to hear about your experience if you proceed or decide against it. For many people, their cars are their second largest expense after housing (or third largest, if we consider taxes). Cars depreciate quickly, so saving money on transportation can leave more of our cash available for investments which do appreciate. Here’s how I hope people will evaluate subscriptions: is the cost of the subscription less than if you pay for the vehicle, insurance, and other costs separately?

FAQs: New 20% Pass Through Tax Deduction

You’ve probably heard about the new 20% tax deduction for “Pass Through” entities under the  Tax Cuts and Jobs Act (TCJA), and have wondered if you qualify. For those who are self-employed, here are the five FAQs:

1. Do I have to form a corporation in order to qualify for this benefit?
No. The good news is that you simply need to have Schedule C income, whether you are a sole proprietor (including 1099 independent contractor for someone else), or an LLC, Partnership, or S-Corporation.

2. How does it work?
If you report on Schedule C, your Qualified Business Income (QBI) may be eligible for this deduction of 20%, meaning that only 80% of your net income will be taxable. Only business income – and not investment income – will qualify for the deduction. Although we call this a deduction, please note that you do not have to “itemize”, the QBI deduction is a new type of below the line deduction to your taxable income. The deduction starts in the 2018 tax year; 2017 is under the old rules.

There are some restrictions on the deduction. For example, your deduction is limited to 20% of QBI or 20% of your household’s taxable ordinary income (i.e. after standard/itemized deductions and excluding capital gains), whichever is less. If 100% of your taxable income was considered QBI, your deduction might be for less than 20% of QBI. If you are owner of a S-corp, you will be expected to pay yourself an appropriate salary, and that income will not be eligible for the QBI. If you have guaranteed draws as an LLC, that income would also be excluded from the QBI deduction.

3. What is the Service business restriction?
In order to prevent a lot of doctors, lawyers, and other high earners from quitting as employees and coming back as contractors to claim the deduction, Congress excluded from this deduction “specified service businesses”, including those in health, law, accounting, performing arts, financial services, athletics, consulting, or any business which relies primarily on the “reputation or skill of 1 or more employees”. Vague enough for you? High earning self-employed people in one of these “specified service businesses” are not eligible for the 20% deduction.

4. Who is considered a high earner under the Specified Service restrictions?
If you are in a Specified Service business and your taxable income is below $157,500 single or $315,000 married, you are eligible for the full 20% deduction. The QBI deduction will then phaseout for income above this level over the next $50,000 single or $100,000 married. Professionals in a Specified Service making above $207,500 single or $415,000 married are excluded completely from the 20% QBI deduction.

5. Should I try to change my W-2 job into a 1099 job?
First of all, that may be impossible. Each employer is charged with correctly determining your status as an employee or independent contractor. These are not simply interchangeable categories. The IRS has a list of characteristics for being an employee versus an independent contractor. Primarily, if a company is able to dictate how you do your work, then you are an employee. It would not be appropriate for an employer to list one person as a W-2 and someone else doing the same work as a 1099.

Additionally, as a W-2 employee, you have many benefits. Your employer pays half of your Social Security and Medicare payroll tax (half is 7.65%). As an employee you may be eligible for benefits including health insurance, vacation, unemployment benefits, workers comp for injuries, and the right to unionize. You would have a lot to lose by not being an employee.

Even still, I expect we are going to see a lot of creative accounting in the years ahead for people trying to reclassify their employment from W-2 to pass-through status. Additionally, businesses which are going to be under the dreaded “specified services” list will be looking for ways to change their industry classification. We will continue to study this area looking for ways for our clients to take advantage of every benefit you can legally obtain.

This information is for educational purposes only and is not to be construed as individual financial advice. Contact your CPA or tax consultant for details on how the new law will impact your specific situation.

9 Ways to Reduce Taxes Without Itemizing

If you used to itemize your tax deductions, chances are you will not be able to do so in 2018 under the new Tax Cuts and Jobs Act (TCJA). While it sounds good that the standard deduction has been increased to $12,000 single and $24,000 married, many tax payers are lamenting that they no longer can deduct certain expenses from their taxes.

As of January 1, we’ve lost these deductions:

  • Miscellaneous Itemized Deductions, including all unreimbursed employee expenses, tax preparation fees, moving expenses for work, and investment management fees.
  • Interest payments on a Home Equity Loan
  • Property Tax and other state and local taxes are now capped at $10,000 towards your itemized deductions.

For a married couple, even if you have the full $10,000 in property tax expenses, you will need another $14,000 in mortgage interest and/or charitable donations before you reach the $24,000 standard deduction amount. Even if you do have $25,000 in deductible expenses, you would effectively be getting only $1,000 more in deductions than someone who spent zero.

Under the new law, people are no longer going to be able to say “it’s a great tax deduction” when buying an expensive home. When you take the standard deduction, you’re not getting any tax benefit from being a homeowner or having a mortgage.

So if you’ve lost your itemized tax deductions for 2018, can you you do anything to reduce your taxes? Thankfully, the answer is yes. I’m going to share with you 9 “above the line deductions” and Tax Credits you can use to lower your tax bill going forward.

Above The Line Deductions reduce your taxable income without having to itemize on Schedule A. All of these savings can be taken in addition to the standard deduction.

1. Increase your contributions to your 401(k) or employer retirement plan. For 2018, the contribution limits are increased to $18,500 and for those over age 50, $24,500. What a great way to build your net worth and make automatic investments towards your future.

2. Many people who think they are maximizing their 401(k) contributions don’t realize they or their spouse may be eligible for other retirement contributions. If you have any 1099 or self-employment income, you may be eligible to fund a SEP-IRA in addition to a 401(k) at your W-2 job. Spouses can be eligible for their own IRA contribution, even if they do not work outside of the home.

3. Health Savings Accounts are unique as the only account type where you make a pre-tax contribution and also get a tax-free withdrawal for qualified expenses. You can contribute to an HSA if you are enrolled in an eligible High Deductible Health Plan. There are no income restrictions on an HSA. For 2018, singles can contribute $3,450 to an HSA and those with a family plan can contribute $6,900. If you are 55 and over, you can make an additional $1,000 catch-up contribution.

4. Flexible Spending Accounts (FSAs) or “cafeteria plans” can be used for expenses such as child care, medical expenses, or commuting. These are often use it or lose it benefits, unlike an HSA, so plan ahead carefully. If your employer offers an FSA, participating will lower your taxable income.

5. The Student Loan Interest deduction remains an above-the-line deduction. This offers up to a $2,500 deduction for qualifying student loan interest payments, for those with an AGI below $65,000 single or $130,000 married filing jointly. This was removed from early versions of the TCJA but made it back into the final version.

Tax deductions reduce your taxable income, but Tax Credits are better because they reduce the amount of tax you owe. For example, if you are in the 24% tax bracket, a $1,000 deduction and a $240 Tax Credit would both reduce your taxes by $240.

Tax Credits should be automatically applied by your CPA or tax software. For example, if you have children, you should get the Child Tax Credit, if eligible. (Since it’s only February, there is still time to make a child for a 2018 tax credit!) If you are low income, still file a return, because you might qualify for the Earned Income Tax Credit. But there are other tax credits where you might be eligible based on your actions during the year. Here are four Tax Credits:

6. The Saver’s Tax Credit helps lower income workers fund a retirement account such as an IRA. For 2018, the Savers Tax Credit is available to singles with income below $31,500 and married couples under $63,000. The credit ranges from 10% to 50% of your retirement contribution of up to $2,000. Note for married couples, if you qualify for the credit, it would be better to put $2,000 in both of your IRAs, and receive two credits, versus putting $4,000 in one IRA and only getting one credit. If you have a child over 18, who is not a dependent and not a full-time student, maybe you can help them fund a Roth IRA and they can get this Tax Credit. Read the details in my article The Saver’s Tax Credit.

7. Originally cut out of the House bill, the $7,500 Tax Credit for the purchase of an electric or plug-in hybrid vehicle was reinstated in the final version of the TCJA signed into law. The credit is phased out after each manufacturer hits 200,000 vehicles sold, so if you were planning to add your name to the 450,000 people on the waitlist for a Tesla Model 3, forget about the Tax Credit. But there are many other cars and SUVs eligible for the credit which you can buy right now. There are no income limits on this credit, but please note that this one is not refundable. That means it can reduce your tax liability to zero, but you will not get a refund beyond zero. For example, if your total taxes owed is $5,200, you could get back $5,200, but not the full $7,500.

8. Child and Dependent Care Tax Credit. To help parents who work pay for daycare for a child under 13, you can claim a credit based on expenses of $3,000 (one child) or $6,000 (two or more children). Depending on your income, this is either a 20% or 35% credit, but there is no income cap.

9. New for 2018: The $500 Non-Child Dependent Tax Credit. If you have a dependent who does not qualify for the Child Tax Credit, such as an elderly parent or disabled adult child, you are now eligible for a $500 credit from 2018 through 2025.

Even with the loss of many itemized deductions, you can reduce your tax bill with these nine above the line deductions and Tax Credits. We are focused on how we can help you achieve Financial Security, whether that is through long-term, diversified investment strategies, by helping you save on taxes, or making sure you have enough money for as long as you live. Thanks for reading!

How The Tax Act Impacts Retirement Planning

With all of the new changes in the Tax Cuts and Jobs Act (TCJA), we’re looking very thoroughly at how this will impact retirement planning. Some of the impacts are direct and immediate, but we are also considering what might be secondary consequences of the new rules in the years ahead.

Although taxes will be slightly lower and more simple for many middle class retirees, the tax changes may mean that some old strategies are no longer effective or that new methods can help reduce taxes or improve retirement readiness. Here are seven things to consider if you are now retired or looking to possibly retire in the next decade.

1. Plan ahead for RMDs. The new lower tax rates will sunset after 2026 and the higher 2017 rates will return. Once you are past age 70 1/2, retirees must take Required Minimum Distributions and must have started Social Security. There are many retirees in their seventies who actually have more income, and therefore way more taxes, than they require to meet their needs. I think we should be doing much more planning in our fifties and sixties to try to reduce retirement taxes, because once you are 70 1/2, you have no control.

See 5 Tax Saving Strategies for RMDs

If you want to reduce your future RMDs, consider doing partial Roth Conversions before age 70 1/2 – converting a small part of your IRA each year, within the limits of your current tax bracket. This is valuable if you now are in a lower tax bracket, 10% to 24%, which is scheduled to rise after 2026.

If you are retiring soon, consider delaying Social Security and starting first with withdrawals from your retirement accounts. Withdrawing cash for several years can help reduce future RMDs, and delaying Social Security benefits past Full Retirement Age provides an 8% annual increase in benefits. That’s a rate of return that is higher than our projected returns on a Balanced (50/50) portfolio. If you delay from age 66 to 70, you’ll see a 32% increase in your Social Security benefit, which reduces longevity risk. Social Security is guaranteed for life, but withdrawals from your portfolio are not!

When higher rates tax return, your (delayed) Social Security benefits are taxable at a maximum of 85% of your benefit, whereas, 100% of your IRA distributions are taxable as ordinary income.

2. Roth 401(k). If you are in a moderate tax bracket today because of the TCJA, you might prefer to contribute to a Roth 401(k) rather than a Traditional 401(k). You don’t get a tax deduction today, but the Roth will grow tax-free and there are no RMDs on a Roth. Therefore, having $24,000 in a Roth is worth more than having $24,000 in a Traditional IRA. In retirement, if you’re in the 25% tax bracket, a $24,000 Traditional account will net you only $18,000 after tax.

Rather than looking to convert your IRA to a Roth after it has grown, the most cost effective time to fund a Roth is likely at the beginning. If you currently have substantial assets in a traditional 401(k) or IRA, consider the Roth option for your new contributions.

3. Second Homes less appealing. The new tax law has placed a cap of $10,000 on the deductibility of state and local taxes. If you own a second home, or are considering purchasing one, this cap may make it more expensive.

Many retirees have paid off their primary residence and then use a home equity loan to purchase a second property. Starting in 2018, you are no longer able to deduct home equity loans. This makes it less attractive to use a home equity loan (or line of credit), and it also makes paying off your mortgage less appealing. If you have a mortgage, it can still be deductible, but if you pay it off, you cannot then borrow from your equity in a tax beneficial way.

If you were previously paying more than $10,000 in state and local taxes, you will either be capped to $10,000, or more likely, be unable to deduct ANY of those taxes, because you are under the standard deduction of $24,000 for a married couple. Going forward, I think more retirees will find it financially appealing to downsize and minimize their housing expenses since they are effectively getting zero tax benefit for their property taxes and mortgage interest.

4. Charitable Strategies. Another casualty of the increased $12,000 / $24,000 standard deduction: Charitable Giving. Most retirees will no longer receive any tax deduction for their donations. Two planning solutions: establish a Donor Advised Fund, or if over age 70 1/2, make use of the Qualified Charitable Distributions from your IRA. We have begun several QCDs this month for our clients!

5. In-State Municipal Bonds. For high income retirees in states with an income tax, it is not difficult to exceed the $10,000 cap on the SALT taxes. In the past, many of these high earners invested in National municipal bonds to get better diversification, even if it meant that they paid  some state income tax on their municipal bonds. “At least you are getting a Federal Tax Deduction for paying the State Income Tax”, they were told. Going forward, they won’t receive that benefit. As a result, I expect that more high earning retirees will want to restrict their municipal bond purchases to those in their home state, where they will not owe any State or Federal tax on this income (especially New York, California, Illinois, etc.). Here in Texas, with no state income tax, we will continue to buy municipal bonds from any and all states.

6. Estate Tax. The TCJA doubled the Estate Tax Exemption from $5.5 million to $11 million per person, or $22 million for a married couple. Now there are only a very small number of people who really need to worry about Estate Taxes. Most retirees will not need a Trust today. (If you might still be subject to the Estate Tax, we can definitely help you.)

7. Health Insurance Costs Will Rise. The repeal of the Individual Mandate of the Affordable Care Act will allow many healthy young people to skip having health insurance. I think that’s a mistake – no one plans to get sick or injured. But what it means for society is a loss of healthier individuals from the insurance risk pool. Adults between age 55 and 65 should expect to see large increases in their individual insurance premiums. More people will be unable to retire until age 65, when they become eligible for Medicare, because they cannot afford the rising individual health insurance premiums. Just this week, a client informed me that they are delaying their retirement for one year because their health insurance bill is increasing from $575 a month to nearly $800.

Wondering how the new tax law will impact your retirement plan? Let’s get together and take a look. Even if your retirement is years away, there are steps we can take today so you can feel confident and prepared that your finances will all be in place when you need them.