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.

Self-Employed? Buy an SUV

In the new Tax Cuts and Jobs Act (TCJA), there are quite a few provisions which will help small business owners, whether you are an Independent Contractor (1099), a self-employed Sole Proprietor, or owner of an LLC or Corporation. One of the key provisions is the expansion of Section 179, which enables owners to expense certain items (take an immediate tax deduction) instead of depreciating those purchases over a longer number of years.

Section 179 has existed for many years, but Congress has continually changed the rules, setting caps on how much you can deduct. At the start of 2017, you could only take bonus depreciation of up to 50%. Under the TCJA, for 2018, bonus depreciation is increased to 100%, the cap increased from $520,000 to $1 million, and now you can also purchase used equipment and receive bonus depreciation.

As a business owner, Section 179 can help you deduct:

  • Equipment for the business
  • Office furniture and office equipment
  • Computers and off the shelf software
  • Business vehicles with a Gross Vehicle Weight Rating (GVWR) of over 6000 pounds

You cannot use Section 179 to deduct the costs of real estate (land, buildings, or improvements), for passenger cars or vehicles under 6000 GVWR, or for property used outside of the United States.

One of the most attractive benefits of Section 179 is the ability to deduct a vehicle for your business. Under Section 179, your first year deduction on a 6000 GVWR vehicle is limited to $25,000. You would first deduct this amount. Second, you are eligible for Bonus Depreciation, which used to be 50%, but now is 100%. That means that a business owner can effectively deduct 100% of any qualifying vehicle in 2018, even if it is a $95,000 Range Rover.

To be deductible, you must use the vehicle for business at least 51% of the time. If you also use the vehicle for personal use, you may only deduct the portion of your expenses attributable to the percentage of business miles. The way to maximize your Section 179 deduction, is to use the vehicle 100% of the time for your business. If the IRS sees you claim 100% business miles on your tax return, you had better have another vehicle for personal use. You might use your spouse’s vehicle, or perhaps keep your old vehicle, for personal miles. Don’t forget that commuting between home and the office are considered personal miles, not business miles.

The 6000 pound GVWR doesn’t mean that the vehicle literally weighs over 6000 pounds, but has a total load rating (vehicle, passengers, cargo) over this weight. If a manufacturer lists the weight of the vehicle, that is not the GVWR; the GVWR is often 1500 or more pounds higher than the vehicle weight. Make sure you are looking specifically at the official GVWR. You can generally find the GVWR printed on a sticker in the driver’s door frame to confirm.

The list of qualifying vehicles varies from year to year and from model to model, but includes most full-size trucks and SUVs. Be careful – sometimes a 4WD model is over 6000, but the 2WD version is not. On one SUV, a model with 3rd row seating was over 6000, but without the extra seats, it was under 6000. An another SUV, 2016 models were over 6000 GVWR, but the new and lighter 2017 model was not.

There are many lists on the internet of which vehicles qualify; in addition to full-size pick-up trucks and vans, most large SUVs such as a Tahoe, Suburban, Expedition, or Escalade are also above 6000 GVWR. Several mini-vans qualify (Honda Odyssey, Dodge Grand Caravan), as do some more medium size SUVs (Jeep Grand Cherokee, Toyota 4Runner, Audi Q7, BMW X5, Ford Explorer). Again, be absolutely certain your vehicle will qualify before making a purchase. One of the nice things about the new law is that now you do not need to buy a new vehicle to qualify for bonus depreciation; used vehicles are also eligible.

Please check with your tax preparer. You cannot deduct more than you earned, so don’t buy a $50,000 SUV if you only show $30,000 in net profits. Lastly, consider these caveats:

  • You have a choice between taking the “standard mileage rate” of 54.5 cent/mile for 2018, or using the “actual cost” method. When you take the standard rate, that already includes depreciation. If you use Section 179 to purchase a vehicle, you are going to be locked in to using “actual costs” for the life of that vehicle. You cannot take the Section 179 deduction upfront and later switch the standard mileage rate.
  • If you are using “actual costs”, you can also deduct your other operating expenses such as gasoline, oil changes, maintenance, insurance, tolls, and parking, but will need to document your costs. Keep those receipts!
  • You may still be required to keep a mileage log to prove you are using the vehicle for more than 50% business miles. If business use falls below 50%, you may be required to pay back some of the depreciation. Let’s just say that would be expensive and a headache.
  • If you depreciate 100% of the cost of the vehicle upfront, that will reduce your cost basis to zero. When you sell the vehicle, you may be creating a taxable gain.

Under the TCJA, these expansions to Section 179 are temporary through 2022; bonus depreciation will be phased back down from 100% to 0%. So if you want to buy an SUV or truck, you have a five-year window to take advantage of this full depreciation.

This tax deduction is especially effective if you have a banner year of high income and anticipate being in a very high tax bracket, because it will let you accelerate future depreciation on a vehicle into the current year, provided the vehicle is purchased and placed into service that year. Please remember that this section 179 deduction is available only to the self-employed and not to W-2 employees.

I feel I should point out that driving a large SUV or truck may not be the most cost effective decision. I am not suggesting everyone rush out and buy a Suburban just to get a tax deduction. But if you do need a vehicle for your business, or were thinking about buying a vehicle this year, it can certainly help to know about this tax deduction. And it might influence which vehicle you choose to buy!

The Seven Deadly Sins of Investing

Successful investing is as much about managing our personal tendencies and behaviors as it is about picking funds. You don’t have to be a financial whiz to be a thriving investor, but you do have to avoid making mistakes. Investing errors do not mark you as a novice or as unintelligent; even professionals can easily fall into these traps. Mistakes are easier to see in hindsight, but in the present moment, the choices we face may not be so obvious.

Here are what I consider to be the Seven Deadly Sins of Investing. I firmly believe that if we can avoid these errors, we will have a much higher chance of success as long-term investors.

1. Not Accepting Losses (Pride)
If you’ve made a losing investment, sell it and move on. Too many investors are unwilling to do this, hoping that if they wait long enough, they will be proven correct or at least get their money back. Unfortunately, this may not occur, and even if it does, there may be an opportunity cost in waiting. With today’s strong markets, you might not have losses, but if you have high-expense funds that are under-performing the market, you should recognize that this too is a mistake and move on.

2. Market Timing (Greed)
Speculating to make as much profit as possible and trying to avoid temporary market drops drives many people to move in and out of the market in a largely futile attempt to improve returns. Neither individual investors nor professionals have demonstrated any success in market timing, although great time and effort are spent in the process. The reality is that market returns are a good return, but when investors say “I want more, I need more”, they are very often rewarded with lower returns rather than higher returns.

3. No Asset Allocation (Lust)
Did you pick the funds for your 401(k) by selecting the options with the best one-year performance? If so, you likely will end up with a poor investment plan, because you are investing based solely on past performance. Don’t fall in love with today’s hot funds, those are the ones that will break your heart at the next downturn, when you discover how much risk they were taking. At any given point in time, one or two categories may dominate returns, fooling investors to think that owning 10 different technology funds makes you diversified. Start with a globally diversified asset allocation and then pick funds that represent each category. Yes, even buy those segments which are out of favor and under-performing today. That’s how you build a better portfolio.

4. Performance Chasing (Envy)
With thousands of mutual funds and ETFs at our disposal, it takes only a few clicks to find a “better performing” fund than the ones currently in your portfolio. There are hundreds of funds which have outperformed their benchmark over the past year. Of course, that number will fall dramatically over time, and typically 80% or more of funds fail to match their benchmark over five or more years. But even still, that means some funds have beaten the index. Unfortunately, there is no predictive power in past returns of actively managed funds, so even those that beat the mark over the last five years are unlikely to continue their streak over the next five years.

Perhaps even more dangerous is when investors “discover” that a sector or country is outperforming. Maybe it’s a technology fund, or Argentina ETF, which has rocketed up in the past six months, and they switch from a diversified fund to a narrow investment. Performance chasing creates a lot of risk which may go unnoticed until it’s too late. We avoid single sector and country funds; almost every argument for these funds is some version of performance chasing.

5. Single Security Risk (Gluttony)
Most of the heart-breaking investing stories I’ve heard from the past 20 years were caused by investors having a large investment in a single company. The 55-year old Nortel employee who had his whole retirement account in his company stock and rode it down from $1 million to $100,000. The Cisco employee who exercised $600,000 in stock options, but kept the shares to try for long-term capital gains; the shares tanked, and he didn’t know he would owe AMT on the original $600,000. The IRS had a lien on his house while he paid them $200,000 over five  years.

Diversification is the only free lunch in investing. The average stock will return about the same as the index by definition, but you take on tremendous risk when you have a concentrated position in one stock. The best choice is to not have too much in any one stock, including that of your employer.

6. Breaking Your Plan (Wrath)
Anger, frustration, and despair were what investors felt in 2008 and 2009, and we will undoubtedly feel the same way when the next bear market occurs. Some investors threw in the towel near the bottom and missed out on much of the rebound. The best way to prevent future frustration is to make sure you have the right asset allocation and understand how your portfolio might perform in up and down years. When you begin with a smart plan and take the time to educate yourself, it is much easier to understand the importance of staying invested rather than allowing emotions to get the best of us.

7. Failing to Monitor (Sloth)
Even for passive investors, you still need to do some work monitoring and managing your portfolio on a regular basis. Rebalancing annually or when funds move a large amount is important to maintain your target risk levels and to create a process to “buy low and sell high”. Additionally, too many investors have stayed with poorly performing active funds and variable annuities they don’t understand, paying high expense ratios, unnecessary 12-b1 fees and sales loads, without having any idea about how they are doing. You only have three or four decades of work and investing, you can’t let 5 or 10 years go by without knowing if your plans are on track. It’s your money, surely you can spend a handful of hours every quarter to analyze your situation and make changes when they are needed.

Successful investing is not complicated, but it can be difficult to have the patience with how boring it can be most of the time and how unpredictable it can be other times. Establish a diversified asset allocation that will help you achieve your long-term goals, then invest in low-cost, tax-efficient vehicles with a good track record. Focus on what you can control: your allocation, costs, and diversification, and don’t worry about the short-term movements of the market.

We all face the temptation of these seven investing sins. Maybe the greatest attribute for an investor is faith. Do what is right, do what is smart, but then to let go of the worry about what will happen today or tomorrow. Market returns will be whatever the market returns. We have no control over the market, but we can focus on our own saving (frugality), patience, and positive thoughts. In the end, the true measure of wealth is more about our faith and gratitude than it is about the dollars and cents.

How Much Income Do You Need In Retirement?

Many people significantly underestimate how much income they will need to maintain their lifestyle in retirement. We’re going to point out how people underestimate their needs, explain why a common “rule of thumb” is a poor substitute, and then share our preferred process.

If we begin with the wrong budget, then our withdrawal rates, target nest egg, and portfolio sustainability are all going to be inaccurate, which is very difficult to correct after you’ve retired.

In general, when I ask someone to estimate their monthly financial needs, they use a process of addition. They think of their housing expenses, utilities, taxes, food costs, etc., and try to add those up. Unfortunately, the number many arrive at can be significantly too low, and here’s how I know.

They tell me that they spent $5,000 a month, or $60,000 last year. But I ask how much they made and they tell me $150,000. How much did they save last year? $30,000. To me, that suggests they spent $120,000, not $60,000. If they only spent $60,000, they would have saved more than $30,000. You either spend or save money; if it wasn’t saved it was spent, even if that spending wasn’t discretionary.

Here’s why most people fail with the “addition method” of trying to create a retirement income budget:

  • They don’t include taxes. Taxes don’t go away in retirement; pensions, Social Security (up to 85%), and IRA withdrawals are all taxable as ordinary income.
  • Unplanned expenses such as home repairs, emergencies, or car maintenance can be substantial and fairly regular, if not consistent or predictable.
  • Your health care costs may be much higher in retirement than you anticipate, especially in the later years of retirement.
  • You may finally have time to pursue activities which you did not have time for while working, such as travel, golf, or spoiling your grandchildren. With an additional 40 hours a week available, you will likely be spending money in new ways.

Some financial calculators use a rule of thumb that most retirees will need 75% (or 70-80 percent) of their pre-retirement income. This is called the “replacement rate”. And while there have been a number studies that confirm this 75% estimate as an average, its applicability on an individual basis is poor.

We know for example, that lower income people will need a higher replacement rate than higher income people. That’s because the lower income levels may have had a lower savings rate, a smaller proportion of discretionary spending, and little tax savings in retirement. Higher income workers may have been saving more and find significant tax savings in retirement, and therefore have a lower replacement rate.

Instead of trying to use an addition method or a one-size-fits-all rule of thumb, I’d suggest using subtraction:

  1. Begin with your current income.
  2. Subtract any immediate savings you will experience in retirement, including: the amount you were actually saving and investing each year, payroll taxes (7.65% if a W-2 employee), and work expenses, if significant.
  3. Examine your sources of retirement income and if you calculate any income tax reduction, subtract those savings.
  4. Consider any increases in retirement spending, starting with health care costs and discretionary spending (travel, hobbies, etc.). Add these back to your spending needs.

Unless you are planning to have paid off your mortgage, substantially downsize your house, get rid of a car, or stop eating out, I think most people will initially continue their spending habits in retirement very much the same as they did while they were working. Like everyone else, retirees spend a significant portion of their income on things which they did not want (property tax, income tax, insurance) and on things which were not planned (replacing a roof, medical expenses, etc.).

Underestimating your retirement income needs could lead to some very painful outcomes, such as depleting your nest egg, being forced to downsize, or impoverishing your spouse after you pass away. You have to still plan for occasional expenses, such as replacing a car, home repairs, and emergencies, in a retirement budget.

If you’ve calculated your retirement income needs and your planned budget is significantly less than your pre-retirement income, please be careful. When the number you reached through addition isn’t the same number I reach through subtraction, it’s possible you are not budgeting for some costs which you currently have and are likely to still have in retirement.