CARES Act RMD Relief for 2020

Posted On March 30, 2020 By Scott Stratton, CFP(R), CFA In College Savings, Financial Planning, Tax Strategies /

The Coronavirus Aid, Relief, and Economic Security CARES Act approved this weekend eliminates Required Minimum Distributions from retirement accounts for 2020. If you have an inherited IRA, also known as a Stretch or Beneficiary IRA, there is also no RMD for this year. We are going dive into ideas from the CARES Act RMD changes and also look at its impact on charitable giving rules.

Of course, you can still take any distribution that you want from your retirement account and pay the usual taxes. Additionally, people who take a premature distribution from their IRA this year will not have to pay a 10% penalty. And they will be able to spread that income over three years.

RMDs for 2020

Many of my clients have already begun taking their RMDs for 2020. (No one would have anticipated the RMD requirement would be waived!) Can you reverse a distribution that already occurred? Not always. However, using the 60-day rollover rule, you can put back any IRA distribution within 60 days.

If you had taxes withheld, we cannot get those back from the IRS until next year. However, you can put back the full amount of your original distribution using your cash and undo the taxable distribution. You can only do one 60-day rollover per year.

For distributions in February and March, we still have time to put those distributions back if you don’t need them. Be sure to also cancel any upcoming automatic distributions if you do not need them for 2020.

If you are in a low tax bracket this year, it may still make sense to take the distribution. Especially if you think you might be in a higher tax bracket in future years. An intriguing option this year is to do a Roth Conversion instead of the RMD. With no RMD, and stocks down in value, it seems like a ideal year to consider a Conversion. Once in the Roth, the money will grow tax-free, reducing your future RMDs from what is left in your Traditional IRA. We always prefer tax-free to tax-deferred.

Charitable Giving under the CARES Act

Congress also thought about how to help charities this year. Although RMDs are waived for 2020, you can still do Qualified Charitable Distributions (QCDs) from your IRA. And for everyone who does not itemize in 2020: You can take up to $300 as an above-the-line deduction for a charitable contribution.

Also part of the CARES Act: the 50% limit on cash contributions is suspended for 2020. This means you could donate up to 100% of your income for the year. This is a great opportunity to establish a Donor Advised Fund, if significant charitable giving is a goal.

Above the $300 amount, most people don’t have enough itemized deductions to get a tax benefit from their donations. Do a QCD. The QCD lets you make donations with pre-tax money. Of course, you could do zero charitable donations in 2020 and then resume in 2021 when the QCD will count towards your next RMD. But I’m sure your charities have great needs for 2020 and are hoping you don’t skip this year.

The Government was willing to forgo RMDs this year to help investors who are suffering large drops in their accounts. To have to sell now and take a distribution is painful. However, if you already took a distribution, you are not required to spend it. You can invest that money right back into a taxable account. In a taxable account, the future growth could receive long-term capital gains status versus ordinary income in an IRA. I’ll be reaching out to my clients this week to explain the 2020 CARES Act RMD rules. Feel free to email me if you’d like our help.

Stock Crash Pattern

Posted On March 21, 2020 By Scott Stratton, CFP(R), CFA In Portfolio Management / 1 Comment

There is a stock crash pattern which is playing out in 2020. We’ve seen this before. We saw it in 2008-2009 with the mortgage crisis, in 2000 with the Tech bubble, and in 1987. The cause of every crash is different, but I’d like you to consider that the way each crash occurs and recovers is similar. Let’s learn from history. What worked for investors in 2000 and 2008 to recover?

I don’t believe in the value of forecasts, and no one can predict how long the Coronavirus will last. This week, things are getting worse, not better. Truthfully, a market bottom could be weeks or months away. No one can predict this, yet it’s human nature to seek certainty and guarantees.

Once we accept that we cannot predict the future, what should we do? I believe the answer is to study what has worked best in the past. That is what we plan to do here at Good Life Wealth Management for our client portfolios. Here’s our playbook.

Stock Crash Pattern Steps

Don’t sell. I had clients who sold in November of 2008 and March of 2009. Luckily, we got them back into the market within a few months. Unfortunately, they still missed out on a substantial part of the initial recovery. The initial recovery will likely be very rapid. We aren’t going to try to time the market.
Rebalance. In our initial financial planning process, we examine each client’s risk tolerance and risk capacity. This leads to a target asset allocation, such as 50/50 or 70/30. Because stocks have fallen so far, a 60/40 portfolio might be closer to 50/50 today. Rebalancing will sell bonds and buy stocks to return to the target allocation. This process is a built-in way to buy low and sell high. (Selling today would be selling low. It’s too late for that.)
Diversify. The investors who have concentrated positions in one stock, one sector, or country jeopardize their ability to recover. Some stocks might not make it out of this recession. Some sectors will remain depressed. Don’t try to pick the winners and losers here. We know that when the recovery does occur, an index fund will give us the diversification and broad exposure we want.
Tax loss harvest. If you have a taxable account, sell losses and immediately replace those positions with a different fund. For example, we might sell a Vanguard US Large Cap fund and replace it with a SPDR US Large Cap fund. Or vice versa. The result is the same allocation, but we have captured a tax loss to offset future gains. Losses carry forward indefinitely and you can use $3,000 a year of losses against ordinary income. Tax loss harvesting adds value.
Stay disciplined, keep moving forward. When it feels like the plan isn’t working, it’s natural to question if you should abandon ship. Unfortunately, we know from past crashes that selling just locks in your loss. Instead, keep contributing to your 401(k) and IRAs, and invest that money as usual.

This Time Is Different

The most dangerous sentence in investing is This time is different. It isn’t true in Bull Markets and it isn’t true in Bear Markets. In the midst of a crash, people abandon hope and feel completely defeated. Maybe you will feel that way, maybe you already feel that way. Maybe you are thinking that this is the Zombie Apocalypse and all stocks are going to zero.

What history shows is that all past crashes have recovered and led to new highs. If you’re going to invest, this is what you have to believe. Even though things are terrible right now, if you think that this time there will be no recovery, I think you will be making a mistake.

The stock market will continue to go down for as long as there are more sellers than buyers. Panic selling is the driver, not fundamentals. No one knows how long that will take. Eventually, we will reach a point of capitulation, when all the sellers will have thrown in the towel. That will be the bottom, visible only in hindsight.

My recommendation is to study past crashes, not for the causes, but to see the charts of the recoveries. I believe that 2020 will have a similar stock crash pattern to 2008, 2000, and previous crashes. We don’t know how long this takes or how deep it goes, but we do know what behavior worked in past crashes.

We have a plan, and I have faith in the plan. Things may be ugly for a while, probably a lot longer than we’d like. All we can control is our response. Let’s make sure that response is based on logic and history, and have faith in the pattern and process.

Investing involves risk of loss. Diversification and dollar cost averaging cannot guarantee a profit.

529 Plan Rules

Posted On March 11, 2020 By Scott Stratton, CFP(R), CFA In College Savings /

College is often a parent’s biggest expense after retirement, yet people are hesitant to save because they don’t know the 529 Plan rules. A 529 College Savings Plan is a terrific wealth building investment for families and has more benefits and flexibility than people realize. While I think investors need to prioritize their own retirement and wealth management, that time horizon is much longer than for college. Retirement accumulation takes 40 years and then will be spent over 20-30 years. College saving is 18 years or less and then 4-6 years of spending.

College costs are growing faster than CPI and it already costs $300,000 for four years at most private universities. If your student changes majors, or decides to stay for a graduate degree, their cost could reach $500,000. 44.7 million American have student loan debt, totaling over $1.6 trillion. Students loans are a looming crisis; 11.1% are presently delinquent or in default and repayment is crushing a lot of Millennials. Many of us had student loans when we were younger, but do not fully appreciate how the magnitude of these loans have grown since we were in college.

Yes, there are a few drawbacks to College Savings Plans, and that’s why I want you to understand the 529 Plan rules. The value is so significant that when people get hung up on the rules, I think they risk missing out on substantial tax benefits and investment opportunities. After all, there are rules for 401(k) accounts and Roth IRAs, but most people are happy to navigate those rules to reap the rewards.

Tax Rules of 529 Plans

The primary benefit of a 529 Plan is tax-free withdrawals for qualified higher educational expenses, such as tuition, room and board, and books. You can now also use a 529 Plan towards private K-12 tuition, up to $10,000 a year. You can also use $10,000 towards student loan repayment.
There is no Federal tax deduction for 529 Plan contributions, however, many states do offer a state income tax deduction. In some states, you have to contribute to that state’s plan to get a deduction. In other states, you can contribute to any plan. For Texas, there is no state income tax, so there is no deduction for a 529 plan contribution.
Contribution limits: most plans have very high limits, often $350,000 or higher. However, most donors want to stay under the annual gift tax exclusion of $15,000 per person. The IRS will let you contribute 5 years at once, or $75,000 per beneficiary. If you and your spouse are funding a 529, you can each contribute $75,000 or $150,000 total under the gift tax exclusion. If you want to contribute more than that, you can. You just have to file an annual gift tax return. You will not owe any taxes until your gifts exceed your unified lifetime exemption of $11.58 million (2020). (Note: certain candidates propose to lower the estate tax threshold to $3.5 million. If that happens, you may want to exceed the gift limits now to reduce a future estate tax liability.)
All 529 Plans offer tax-deferred growth, so you pay no taxes on interest or capital gains annually. Now the part that stops everyone in their tracks: non-qualified withdrawals are subject to income tax and a 10% penalty.

Tax/Penalty Only on Earnings

Let’s dissect that a bit more, because it’s not as bad as you might think. The income tax and penalty apply ONLY to the earnings portion, not the whole withdrawal. For example, if you contributed $50,000 to a 529 and it grew to $70,000, you would have $20,000 in earnings. Withdraw the whole $70,000 for a non-qualified reason and you would pay a $2,000 penalty and the $20,000 earnings would be treated as ordinary income. At the 24% tax bracket, you’d pay $4,800 in income taxes.

Withdrawals are pro-rata, meaning earnings are proportional for each distribution. A non-qualified withdrawal from a 529 plan is not subject to the 3.8% net investment tax (the Medicare surtax), if you earn over $200,000 single or $250,000 married.

Ways Around the Penalty and Tax

Everyone is frozen by the thought they might have to pay a penalty, but there are exceptions and ways to avoid it. Here are more 529 Plan rules to know:

If the beneficiary dies or becomes disabled, the 10% penalty is waived. If they receive a scholarship, the penalty is waived. Earnings are still taxable, but no penalty.
You can change the beneficiary to another child, grandchild, other relative, or even yourself. If they can use the money for higher education, you’re back to tax-free withdrawals. If you have two or more children or grandchildren, I think it’s pretty likely that someone in your family is going to be able to use the money.
Kid not going to college? You can do nothing and wait. Just because they turned 18, you don’t have to withdraw the money. It never becomes their money and you never lose control of the funds. You can keep it deferred for as long as you like. Maybe they later go to trade school or an apprenticeship program. That’s a qualified 529 expense. Or maybe they have kids of their own down the road. Now you have a college account for your grandkids.
You can give the money to your kid if you want. The taxes are payable to the distributee. Have the 529 distribute the money to your kids and they will owe any tax and penalty on the gains. (And they may be in a lower tax bracket than you. So, this is good tax planning, not being selfish on your part.)
For long-term care. Let’s say your kids don’t use the money and you don’t have grandchildren and this account sits there for decades just growing tax-deferred. If you become disabled you can change the beneficiary to yourself and receive the disability waiver on the penalty.

More Benefits of a 529 Plan

A 529 remains the property of you, the owner. If you instead funded and UGMA or UTMA, that becomes the property of the beneficiary at the age of majority (18 or 21; 21 in Texas). UGMA equals You Give Money Away. They can spend it on anything they want, including whatever terrible decisions you can imagine. No one is thinking this is possible when someone is three, but you give up all your control with an UGMA.
Creditor Protection. Are you a business owner, doctor, or professional worried about getting sued? 529 Plans are creditor protected.
Financial Aid. A 529 plan is a parental asset, subject to a 5.6% expected family contribution from the FAFSA financial aid process. Put that asset in the child’s name and the expected contribution is 20% a year. A 529 plan in the grandparent’s name is not reportable on the FAFSA.
A 529 Plan will not be part of your taxable estate. You can and should name a successor trustee/owner of the funds for after you pass away. As such, 529 plan could be an important way to create a legacy for your family.

It’s Your Family’s Future

If you like the idea of Tax-Free Growth, a 529 Plan could benefit your family. When people get too worried about the 10% penalty and the other 529 Plan rules, they are often paralyzed to take action. Investors contribute to 401(k)’s and Roth IRAs that have a 10% penalty, but they seem to think that with a 529 it’s going to be worse. To get the best tax benefit from a 529, you want to start as early as possible. Opening a 529 plan for a 17 year old going to college in the Fall does not leave you much time for tax-free growth.

Parents and Grandparents want their children have the same opportunities they had. Many would like for their kids to go to the same or better university than they attended. Let’s start with estimating what four years would cost and what it would take to fund that expense monthly starting now.

Don’t have kids yet? Open a 529 Plan in your own name. When your child is born, you can change the beneficiary to their name. We can fund a 529 with a lump sum, or you can set up small monthly contributions. Expenses on 529 plans have been declining in recent years and many offer low-cost index based investment options. You have daily liquidity, however, most plans restrict you to two trades a year to discourage market timing. Almost all plans offer age-based funds, which adjust to become more conservative as a beneficiary approaches college age.

I hope to make it easy to understand the 529 Plan rules, so you can get started. Please don’t hesitate to email me with your questions, I’m here to help.

2020 Stock Market Crash

Posted On March 8, 2020 By Scott Stratton, CFP(R), CFA In Behavioral Finance /

This month will likely be called the 2020 Stock Market Crash in the years ahead. Investopedia defines a crash as a double digit drop over a few days as the result of a crisis or catastrophic event. A crash typically occurs after a period of speculation which drives stock prices to above average valuations. Panic is a hallmark of a crash, versus a Bear Market. Certainly, we have met the definition of a crash.

Risk is perceived as danger when it occurs, but only in hindsight do we see another definition of risk: opportunity. If you look at the purchases you made in your 401(k) back in 2008 and 2009, you may be astonished by the gains you made at those low prices!

Your emotional response to a crash may be to ask if you should sell. But then you might miss out on today’s opportunities. Even if you are fully invested today, consider these five actions instead of selling.

Five Opportunities

Keep buying. Dollar cost average in your 401(k), IRA or other accounts. The shares you buy at a low price could be your largest future gains. If you have not made your IRA contribution for 2019 or 2020, this might be a good time.
Roth Conversion. Thinking about converting part of your IRA to a Roth? If so, you would now pay 11% less in taxes versus last month. After that, your gains will be tax-free in the Roth.
Rebalance. Hopefully you started with a defined allocation, like 60/40 or 70/30. If that has subsequently gotten off-target, now may be an opportune moment to make rebalancing trades.
Replace low yielding bonds. Look at the SEC Yield of your bond funds. The SEC Yield measures the yield to maturity of a fund’s bonds and subtracts the expense ratio. It is the best measure of expected returns for a bond fund. Bonds can work as portfolio ballast: a way to offset the risk of stocks. If that is your objective, stay safe. Unfortunately, the actual contribution of bonds to your portfolio return is terrible, maybe 2%, or even less than 1% if you own short-term treasuries. Instead, what I find attractive after this crash is Preferred Stocks, non-callable CDs (versus Treasuries of the same duration), and Fixed Annuities. If your SEC Yields are unacceptable consider changes, but proceed with great caution. Above all, avoid trading down from a safe bond to a risky bond just for a higher yield.
Do nothing. Markets go up and down. You have the choice of just ignoring it. Selling on today’s panic is the worst type of market timing, giving into fear. So, take a deep breath and realize that after the crash it is often best to hold.

Work on Your Financial Plan

There’s more to your financial success than just whether the stock market is up or down. Ask yourself the following questions:

Am I on track for retirement?
Do I have an Estate Plan?
Am I prepared for my children’s college education expenses?
Have I protected my family with a term life insurance policy? Additionally, are there risks to my career, business, health, or family which I need to address?
Do I have a disability and long-term care plan?
How am I addressing my charitable goals?
Are there additional ways to save on taxes?
Should I refinance my mortgage?
Am I eligible for a Health Savings Account or Flexible Spending Account?
Have I calculated the optimal age to begin Social Security for myself and my spouse?

Don’t let investing in the stock market consume all your attention, because it is only one piece of your financial plan!

Think Long Term

Risk is danger and risk is opportunity. Instead of worrying about this month, imagine that it is 2021 or 2022 and the market has recovered. What would you have wished you had done in the 2020 Stock Market Crash?

Ignoring the panic of the day isn’t easy. Thankfully, a good investor doesn’t have to make predictions about the market going up or down. We can’t control that. The key is managing how you respond when the market is at its worst. Finally, if you know you need work on your financial plan or would benefit from professional advice on managing your portfolio, I am here to help.

Past performance is no guarantee of future results. Stock market investing involves risk of loss of principal. Dollar cost averaging does not guarantee a gain.

Coronavirus Stock Market Damage

Posted On February 29, 2020 By Scott Stratton, CFP(R), CFA In Behavioral Finance /

Welcome to the Coronavirus Stock Market. After setting an all-time high on February 19, the market plummeted last week, and is down nearly 15% from its highs. As the virus spreads, the economic impact is growing. Companies are sending employees home, shuttering manufacturing, leading to less travel, less restaurant meals, and lower consumer spending.

As an investor, what should you do, given that we don’t know how much worse the contagion will grow? I don’t know. No one knows. No one has a crystal ball to know how the disease will spread or how the economies or markets will be impacted. Recognizing that this is unknowable information is the key to understanding what to do.

A history lesson may help. Big drops of 3.5% in a day are somewhat rare and they are felt as being quite shocking. We had a couple of days like that this week. Over the past 33 years, there have been 55 days of a 3.5%+ drop. In 45 of those instances, the market was higher 12 months later. Much higher, on average 20% higher. In only 10 of 55 drops was the market lower a year later. (Source: Barrons) Those aren’t bad odds, and the reward for staying invested could be worthwhile.

What I did this week

If it helps, let me share what I did in my own portfolio this week. I did not sell anything. However, I did have a couple of bonds which were called. With the new cash in my account, I revisited my asset allocation. Since equities are down, I was presently underweight to my target percentage of stocks. So, I purchased more shares of stock Exchange Traded Funds (ETFs) that I own.

Sure, it’s possible that the purchases I made this week will be even lower next week. But I’m not trying to time the market. No one can tell you when the Coronavirus stock market carnage will cease and it will be safe to invest again. We are stuck with uncertainty no matter when we make a decision. So the optimal decision, I think, is to stick to a disciplined process. Create a diversified target asset allocation and hold that portfolio regardless of epidemics, elections, wars, or any other human events. Rebalance your portfolio periodically, when you have cash to add, or when your allocation has shifted.

If you made any recent purchases in taxable accounts, consider harvesting your losses. Immediately repurchase another fund to maintain your target allocation. This is solely to lock in a capital loss for tax purposes, so be careful to not change your asset allocation.

The Pain of Losses

There’s an old saying on Wall Street that stocks take the stairs up but the elevator down. Gains are slow and plodding, but losses are straight down. That’s definitely what happened this week. From a psychological perspective, the pain of a 10% loss is more acute than the thrill of a 10% gain. This increases likelihood of making investment errors.

Everyone agrees that we shouldn’t try to time the market when the market is rising. But when the market is down, we have to really resist the urge to go to cash, when our amygdala is screaming Run! Hide! Get out of the market before you lose everything! That biological mechanism may have helped our ancestors avoid being eaten by a saber-toothed tiger, but is a detriment to long-term investing.

Bonds and Alternatives

While stocks have been falling, investors seem to be buying bonds no matter how low the yield. As money floods into bonds, prices go up and yields go down. The 10-Year Treasury reached an all-time low yield on Friday of 1.09%. Unbelievable, and yet this didn’t even make any headlines this week. With low rates, expect virtually all of your callable corporate and municipal bonds to get called. And then good luck finding a replacement – I’m seeing 2% yields at 10+ years. That’s terrible for a BBB-rated credit.

This is a good time to refinance your mortgage. If you can save 1 percent or more, it is probably going to be worth the change. That’s just about the only benefit of the low interest rates.

Today’s yields make bonds quite unappealing and dividend stocks more attractive. Some good companies are down significantly (why is Chevron down 25% this year?). We were buying stocks at higher prices last month, and if you like those companies, you should like them even better when they are on sale. Bonds won’t even keep up with inflation and the low interest rates will push more investors into stocks.

Stocks have much higher risks than bonds, and it is simply unacceptable for most investors to be 100% in stocks. Fixed, multi-year guaranteed annuities have better yields than treasury, corporate, and municipal bonds and are also guaranteed. We can get over 3% on a 5-year annuity, versus 0.87% for a 5Y Treasury or 1.6% on a 5Y CD. Annuities remain very unpopular, but I think they are a better fixed income investment than bonds if you do not need liquidity. I suggest laddering fixed annuities over a 5-year maturity, 20% into five sleeves.

Our Alternative Investment in Preferred Stocks were down a couple of percent this week, but nothing like the bloodbath in stocks. Some preferreds that were trading near $26 are now trading near $25. With a $25 par price, this is an excellent entry point for investors.

The Coronavirus stock market impact has been shocking. Investors are not going to be happy when they open their February statements. Realizing that we cannot predict the future, we need to avoid the “flight” response. The challenge for an investor remains to keep the discipline to stick to their plan of a diversified allocation. Rebalance and hold.

The 12% Roth Conversion

Posted On February 23, 2020 By Scott Stratton, CFP(R), CFA In Retirement Planning /

If you make less than $117,150, you’ve got to look into the 12% Roth Conversion. For a married couple, the 12% Federal Income tax rate goes all the way up to $89,450 for 2023. That’s taxable income. With a standard deduction of $27,700, a couple could make up to $117,150 and remain in the 12% bracket. Above those amounts, the tax rate jumps to 22%.

For those who are in the 12% bracket, consider converting part of your Traditional IRA to a Roth IRA each year. Convert only the amount which will keep you under the 12% limits. For example, if you have joint income of $70,000, you could convert up to $47,150 this year.

This will require paying some taxes today. But paying 12% now is a great deal. Once in the Roth, your money will be growing tax-free. There will be no Required Minimum Distributions on a Roth and your heirs can even inherit the Roth tax-free. Don’t forget that today’s tax rates are going to sunset after 2025 and the old rates will return. At 12%, a $47,150 Roth conversion would cost only $5,658 in additional taxes this year. And then you will have that $47,150 growing with no future tax liabilities.

Take Advantage of the 12% Rate

If you have a large IRA or 401(k), the 12% rate is highly valuable. The key to the 12% Roth Conversion is doing it repeatedly over a period of years. If you have eight years where you can convert $40,000 a year, that’s going to move $320,000 into a tax-free account. Once you start Required Minimum Distributions, you really won’t have a choice about taking those taxable distributions. I have so many clients who don’t need their RMDs, but are forced to take out their money.

Here are some scenarios to consider where you might be in the 12% bracket:

One spouse is laid off temporarily, on sabbatical, or taking care of young children. Use those lower income years to make a Roth Conversion. This could be at any age.
One spouse has retired, the other is still working. If that gets you into the 12% bracket, make a conversion.
Retiring in your 60’s? Hold off on Social Security so you can make Roth Conversions. Once you are 73, you will have both RMDs and Social Security. It is amazing how many people in their seventies are getting taxed on over $117,150 a year once they have SS and RMDs! These folks wish they had done Conversions earlier, because after 73 they are now in the 22% or 24% bracket.

Retiring Soon?

Considering retirement? Let’s say you will receive a $50,000 pension at age 65. (You are lucky to have such a pension – most workers do not!) For a married couple, that’s only $22,300 in taxable income after the standard deduction. Hold off on your Social Security and access your cash and bond holdings in a taxable account. Your Social Security benefit will grow by 8% each year. Spend the cash or bonds and defer the Social Security.

Now you can convert $67,000 a year into your Roth from age 65 to 70. That will move $335,000 from your Traditional IRA to a Roth. Yes, that will be taxable at 12%. But at age 73, you will have a lower RMD – $12,641 less in just the first year.

When you do need the money after 73, you will be able to access your Roth tax-free. And at that age, with Social Security and RMDs, it’s possible you will now be in the 22% tax bracket. I have some clients in their seventies who are “making” over $250,000 a year and are now subject to the Medicare Surtax. Don’t think taxes go away when you stop working!

How to Convert

The key is to know when you are in the 12% bracket and calculate how much to convert to a Roth each year. The 12% bracket is a gift. Your taxes will never be lower than that, in my opinion. If you agree with that statement, you should be doing partial conversions each year. Whether that is $5,000 or $50,000, convert as much as you can in the 12% zone. You will need to be able to pay the taxes each year. You may want to increase your withholding at work or make quarterly estimated payments to avoid an underpayment penalty.

What if you accidentally convert too much and exceed the 12% limit? Don’t worry. It will have no impact on the taxes you pay up to the limit. If you exceed the bracket by $1,000, only that last $1,000 will be taxed at the higher 22% rate. Conversions are permanent. It used to be you could undo a conversion with a “recharacterization”, but that has been eliminated by the IRS.

While I’ve focused on folks in the 12% bracket, a Conversion can also be beneficial for those in the 22% bracket. The 22% bracket for a married couple is from $89,451 to $190,750 taxable income (2023). If you are going to be in the same bracket (or higher) in your seventies, then pre-paying the taxes today may still be a good idea. This will allow additional flexibility later by having lower RMDs. Plus, a 22% tax rate today might become 25% or higher after 2025! Better to pay 22% now on a lower amount than 25% later on an account which has grown.

A Roth Conversion is taxable in the year it occurs. In other words, you have to do it before December 31. A lot of tax professionals are not discussing Roth Conversions if they focus solely on minimizing your taxes paid in the previous year. But what if you want to minimize your taxes over the rest of your life? Consider each year you are eligible for a 12% Roth Conversion. Also, if you are working and in the 12% bracket, maybe you should be looking at the Roth 401(k) rather than the Traditional option.

Where to start? Contact me and we will go over your tax return, wage stubs, and your investment statements. From there, we can help you with your personalized Roth Conversion strategy.

Preferred Stocks Belong in Your Portfolio

Posted On February 15, 2020 By Scott Stratton, CFP(R), CFA In Portfolio Management /

Why do we own Preferred Stocks? US Stocks are expensive today. Bond yields are very low. Neither are terribly attractive. With any allocation, the expected return of the portfolio going forward is lower than historical returns. Risks, however, remain in the market. That’s not a dire prediction, just a statement of fact. We hope 2020 is another great year, like 2019.

The challenge for a portfolio manager like myself, is to diversify and find the sweet spot of risk and return. Because of today’s high prices of stocks and bonds, we include a 10% allocation to alternative investments. We’re looking for things which might offer a higher yield than bonds, but with less risk than stocks. And ideally, with a low correlation to stocks or bonds.

What is a Preferred Stock?

A Preferred Stock is a hybrid security. It has characteristics of both a common stock and a bond. It trades like a stock and pays a quarterly dividend. Like a bond, it has a fixed rate of return and a par value. With a Par value of $25, a company issues a Preferred stock at $25 and can redeem it at $25.

(How well do you understand bonds? Read: A Bond Primer.)

Historically, Preferred Stocks were “perpetual”, meaning that they had no ending date. More commonly today, Preferred Stocks are callable. Companies can buy back their Preferreds at $25 after a specific date in the future, most often five years after issue. Other Preferreds have a specific redemption date, when the company will buy back all of the shares.

Dividends of a Perpetual Preferred are typically qualified dividends. They qualify for the 15% tax rate on dividends. Other Preferreds, with redemption dates, may treat dividends as ordinary income, like bonds. As a result, we prefer to buy Preferreds in an IRA.

The Investment Rationale

We are interested in Preferreds which are callable or have a redemption date of less than 10 years. The reason is that, unlike perpetual Preferreds, these ones are trading for close to $25 a share. The ones we own have coupons of 4.75% to 7.25% or higher. We are generally paying a little above $25 today, but plan to hold until the shares are redeemed or called. (We can also sell them any day if desired, as they are liquid.)

You buy Preferreds for the dividend. They do not offer any growth. But that also means we have more stability. They tend to trade right around $25. And for those with a redemption date, we know the company will buy them for $25. So, any price volatility is likely a temporary fluctuation.

I am featured in this article “Are Preferred Stocks Preferable?” at US News & World Report from the summer of 2016. Since then, the relative attractiveness of Preferreds versus common stocks has improved significantly. Today, I think they have a place in our portfolios.

How to Invest in Preferred Stocks

Because Preferred Stocks carry the credit risk of the company, we prefer to purchase a basket rather than just one. Typically, we have a 5-6% allocation to Preferreds per household, and will buy at least five different issuers. That gives us some diversification of risks. Like any stock or bond, if the company goes bankrupt, you lose money. That’s why we diversify with a basket of small positions.

There are also funds and ETFs for Preferreds which offer a bigger basket. But, I prefer to pick the duration and companies I want. Also, we can save clients the expense ratio of a fund, often 0.50% to 1% a year. That would take a big bite out of your yield.

Preferreds are a niche investment and not a part of our core holdings. Given today’s market, we think they offer a nice complement to our traditional stock and bond holdings. Most advisors have never purchased a Preferred Stock, but I have been analyzing and trading the sector for over 15 years. We generally buy on the open market, but this month we have also participated in IPOs of Preferreds from Wells Fargo, AT&T, and Capital One. People want these yields. They’re no magic bullet, but Preferred Stocks are an interesting tool and we think a good fit for what our clients want.

If you’re looking for more than just a generic robo portfolio or a target date fund, let’s talk. Our Premiere Wealth Management Portfolios are for investors with at least $250,000 to invest.

Investment carries risk of loss of principal. Preferred Stocks are not guaranteed.

Tax Planning – What are the Benefits?

Posted On February 3, 2020 By Scott Stratton, CFP(R), CFA In Tax Strategies /

Taxes are your biggest expense. Tax Planning can help. A typical middle class tax payer may be in the 22% or 24% tax bracket, but Federal Income Taxes are only one piece of their total tax burden. They also pay 7.65% in Social Security and Medicare Taxes. If they’re self-employed, double that to 15.3%. Most of my clients here in Dallas pay $6,000 to $20,000 a year in property taxes, more if they also have a vacation home. After getting to pay taxes on their earnings, they are taxed another 8.25% when they spend money, through sales tax.

High earners may pay a Federal rate of 35% or 37%, plus a Medicare surtax of 0.9% on earned income and 3.8% on investment income. There’s also capital gains tax of 15% or 20%. Business owners get to pay Franchise Tax and Unemployment Insurance to the state. Add it all up and your total tax bill is probably a third or more of your gross income.

I’m happy to pay my fair share. But I’m not looking to leave Uncle Sam a tip on top of what I owe, so I want make sure I don’t overpay. I help people with their investments, prepare to retire someday, and to make sure they don’t get killed on taxes. It’s vitally important.

The tax code is complex and changes frequently. We have talked about how the Tax Cuts and Jobs Act changes how you should approach tax deductions. This past month, I’ve been talking and writing about the new SECURE Act passed in December.

It’s February and people are receiving their W-2s and 1099s and starting to put together their 2019 tax returns. I like to look at my client tax returns. We can often find ways to help you reduce your tax burden and keep more of your hard-earned money, completely legally.

Two sets of eyes are better than one.

I’m not a tax preparer, and I don’t mean to suggest that your tax preparer is making mistakes. While I have, of course, seen a couple of errors over the years, they are rare. However, I think there is a benefit to having a second set of eyes on your tax return. I may look at things from a different perspective than your CPA or accountant. As a Certified Financial Planner professional and Chartered Financial Analyst, I have extensive training on Tax Planning and have been doing this for over 15 years.

Tax preparers are great at looking at the previous year and calculating what you owe. What I sometimes find is that they don’t always share proactive advice to help you reduce taxes going forward.

For example, this month, I met with an individual and looked over his 2018 tax return. He would have qualified for the Savers Tax Credit but did not contribute to an IRA. I told him “your CPA probably mentioned this, but last year, if you had contributed $2,000 to a Roth IRA, you would have received a $1,000 Federal Tax Credit”. Nope, he had never heard about this from his long-time preparer, and let’s just say he was displeased. While his tax return was “correct”, it could have been better.

When you become a client of Good Life Wealth Management, I will review your tax return and look for strategies which could potentially save you a significant amount of money. Such as?

5 Areas of Tax Planning

1. Charitable Giving Strategies. It has become more difficult to itemize your deductions and get a tax savings for your charitable giving. We identify the most effective approach for your situation. For example, donating appreciated securities or bunching deductions into one year. If you’re 70 1/2, you could make QCDs from an IRA. Or we could front-load a Donor Advised Fund to take a deduction while you are in a higher tax bracket before retirement. If you are planning to make significant donations, I can help your money go father and have a bigger impact.

2. Tax-advantaged accounts: which accounts are you eligible for and will enable the greatest contribution? No one can tell without looking at your tax return. Let’s maximize your pre-tax contributions to company retirement plans, IRAs, Health Savings Accounts, and FSAs. Often someone thinks they are doing everything possible and we find an additional savings avenue for them or their spouse.

3. Investment Tax Optimization. Do you have a lot of interest income reported on Schedule B? Why are those bonds not in your IRA or retirement account? Are your investments creating short-term gains in a taxable account? Do you have REITs which don’t qualify for the qualified dividend rate? You could benefit from Asset Location Optimization.

Showing a lot of Capital Gains Distributions on Schedule D? Many Mutual Funds had huge distributions in 2019. Let’s look at Exchange Traded Funds which have little or no tax distributions until you sell. There may be more tax-efficient investments for your taxable accounts. Are you systematically harvesting losses annually?

4. If you make too much for a Roth IRA, are you a good candidate for a Backdoor Roth IRA?

5. Tax-Efficient Retirement Income. What is the most effective way to structure your withdrawals from retirement accounts and taxable accounts? When should you start pensions or Social Security? How can you minimize taxes in retirement?

I could go on about tax-exempt municipal bonds, tax-free 529 college savings plans, the Medicare surtax, or reducing taxes to your heirs. It’s a long list because almost every aspect of financial planning has a tax component to it.

Most Advisors Aren’t Doing Tax Planning

Even though taxes are your biggest expense, a lot of financial advisors aren’t offering genuine tax planning. For some, it’s just not in their skill set, they only do investments. For a lot of national firms, management prohibits their advisors from offering tax advice for compliance reasons. Other “advisors” specialize in tax schemes which are designed primarily to sell you an insurance product for a commission. I’m in favor of the right tool for the job, but if you only sell hammers, every problem looks like a nail.

Tax Planning is making sure that all the parts of your financial life are as tax-efficient as possible. If you’d like a review of your 2018 return before you complete your 2019 taxes, give me a call. I get a better understanding of a client’s situation by reviewing their taxes and I really enjoy digging into a tax return.

While I can’t guarantee that we can save you a bunch of money on your taxes, we do often have ideas or suggestions to discuss with your tax preparer. That way you can participate more than just dropping off a pile of receipts. If you do your taxes yourself, as many do today, you can ask me “Are there any additional ways to reduce my taxes?” Let’s find out.

Tax Savings under the SECURE Act

Posted On February 2, 2020 By Scott Stratton, CFP(R), CFA In Tax Strategies /

A few weeks ago, we gave an overview of key changes under the SECURE Act Retirement Bill. Today we are going to dive into a few questions that investors have been asking about the Act. Here’s how the SECURE Act can help you reduce your tax bill.

RMDs and QCDs

1. Required Minimum Distributions are pushed to age 72 from 70 1/2. If you turned 70 1/2 in 2019, even though you won’t reach 72 in 2020, you will still be responsible for taking RMDs. You will not get to skip a year.

2. Although RMDs have been pushed to 72, the age for Qualified Charitable Distributions (QCDs) was unchanged at age 70 1/2. I’ve read some articles suggesting people under 72 not do QCDs now. Sure you could wait until after 72 to count a QCD towards your RMD. However, most donors I know want to support their favorite charities annually. So if you are 70 1/2 and want to make a $5,000 charitable donation this year, consider three scenarios:

You could make a cash donation. To be able to deduct your charitable donations, you have to have more than $12,400 (single) or $24,800 (married) in itemized deductions for 2020 It’s likely that a $5,000 donation nets you no tax benefit.
Or you could donate appreciated securities. If you had a $5,000 position with a $2,500 cost basis, donating those shares would save you $375 in long-term capital gains. (Most tax payers are in the 15% LT rate.)
With a QCD, it wouldn’t save you any taxes this year. But it would remove $5,000 from your IRA, saving you in future taxes. If you are in the 24% tax bracket, that would save $1,200 in future income taxes. That’s still the best choice of these three options.

529 Plans Can Pay Student Loans

3. Beneficiaries of a 529 College Savings Plan can now use their account to pay up to $10,000 in student loans. This will help those who have finished and have leftover funds. But also, there could be an advantage to deliberately taking $10,000 in Stafford Loans in the first or second year of college to receive deferment on the loan until after you’ve graduated. Then the funds can grow for four or so years while the student receives a loan which has no payments or interest accruing. Upon the end of the deferment period, you could use the 529 to pay off the loan in full. Additionally, owners of a 529 plan can also use the funds to pay $10,000 towards a sibling’s student loans, should the original beneficiary not need the funds.

Stretch IRA Eliminated in 2020

4. With the elimination of the Stretch IRA, we previously shared tax saving strategies for owners of larger IRAs. Here’s one additional approach for a married couple who both have IRAs and plan to leave them to their children. Assuming both spouses have more funds than they will need in their lifetime, consider making your children the primary beneficiaries of your IRAs. Otherwise, the traditional approach of leaving each IRA to the spouse will ultimately double up the tax burden on the children as well as increasing RMDs for the surviving spouse. Since all inherited IRAs must be distributed in 10 years or less, it may be more tax efficient for the children to receive two distributions spread out, rather than one combined inheritance from the second-to-pass parent. Contact me for an examination of your specific situation.

Annuity for Retirement Income?

5. 401(k) plans can now offer annuities for retirees to create a guaranteed income stream. This sounds like a big deal, but you have always been able to do this once you roll over your 401(k) into an IRA. And it still might be better to buy an annuity in an IRA for a couple of reasons:

You could shop for the best annuity product for you. Otherwise, you are stuck with whatever the plan sponsors have decided to offer. It could be that another insurance company offers higher payout rates. Contact me for quotes if this is something you are considering.
Your State Insurance Guaranty Association probably only protects $250,000 in losses should an Insurance Company go bankrupt. Some of the biggest ones, including AIG, almost failed back in 2009. If I had $400,000 or $600,000 to invest in annuities, you bet I’m going to divide that between two or three companies to stay under the covered limits. (Read more on the Texas Guaranty Association.)

Changes in law are common and an important reason for having an on-going financial plan with a professional who is staying informed. If you have questions about how the SECURE Act Retirement Bill could be beneficial or detrimental to your situation, please contact me. Our first meeting is always free.

SECURE Act Abolishes Stretch IRA

Posted On January 20, 2020 By Scott Stratton, CFP(R), CFA In Financial Planning, Retirement Planning /

The SECURE Act passed in December and will take effect for 2020. I’m glad the government is helping Americans better face the challenge of retirement readiness. As a nation, we are falling behind and need to plan better for our retirement income.

It’s highly likely that the SECURE Act will directly impact you and your family. Six of the changes are positive, but there’s one big problem: the elimination of the Stretch IRA. We’re going to briefly share the six beneficial new rules, then consider the impact of eliminating the Stretch IRA.

Changes to RMDs and IRAs

1. RMDs pushed to age 72. Currently, you have to begin Required Minimum Distributions from your IRA or 401(k) in the year in which you turn 70 1/2. Starting in 2020, RMDs will begin at 72. This is going to be helpful for people who have other sources of income or don’t need to take money from their retirement accounts. People are living longer and working for longer, so this is a welcome change.

2. You can contribute to a Traditional IRA after age 70 1/2. Previously, you could no longer make a Traditional IRA contribution once you turned 70 1/2. Now there are no age limits to IRAs. Good news for people who continue to work into their seventies!

3. Stipends, fellowships, and home healthcare payments will be considered eligible income for an IRA. This will allow more people to fund their retirement accounts, even if they don’t have a traditional job.

529 and 401(k) Enhancements

4. 529 College Savings Plans. You can now take $10,000 in qualified distributions to pay student loans or for registered apprenticeship programs.

5. 401(k) plans will cover more employees. Small companies can join together to form multi-employer plans and part-time employees can be included

6. 401(k) plans can offer Income Annuities. Retiring participants can create a guaranteed monthly payout from their 401(k).

No More Stretch IRAs

7. The elimination of the Stretch IRA. This is a problem for a lot of families who have done a good job building their retirement accounts. As a spouse, you will still be allowed to roll over an inherited IRA into your own account. However, a non-spousal beneficiary (daughter, son, etc.) will be required to pay taxes on the entire IRA within 10 years.

Existing Beneficiary IRAs (also known as Inherited IRAs or Stretch IRAs) will be grandfathered under the old rules. For anyone who passes away in 2020 going forward, their IRA beneficiaries will not be eligible for a Stretch.

If you have a $1 million IRA, your beneficiaries will have to withdraw the full amount within 10 years. And those IRA distributions will be taxed as ordinary income. If you do inherit a large IRA, try to spread out the distributions over many years to stay in a lower income tax bracket.

For current IRA owners, there are a number of strategies to reduce this future tax liability on your heirs.
Read more: 7 Strategies If The Stretch IRA Is Eliminated

If you established a trust as the beneficiary of your IRA, the SECURE Act might negate the value and efficacy of your plan. See your attorney and financial planner immediately.

IRA Owners Need to Plan Ahead

The elimination of the Stretch IRA is how Congress is going to pay for the other benefits of the SECURE Act. I understand there is not a lot of sympathy for people who inherit a $1 million IRA. Still, this is a big tax increase for upper-middle class families. It won’t impact Billionaires at all. For the average millionaire next door, their retirement account is often their largest asset, and it’s a huge change.

If you want to reduce this future tax liability on your beneficiaries, it will require a gradual, multi-year strategy. It may be possible to save your family hundreds of thousands of dollars in income taxes. To create an efficient pre and post-inheritance distribution plan, you need to start now.

Otherwise, Uncle Sam will be happy to take 37% of your IRA (plus possible state income taxes, too!). Also, that top tax rate is set to go back to 39.6% after 2025. That’s why the elimination of the Stretch IRA is so significant. Many middle class beneficiaries will be taxed at the top rate with the elimination of the Stretch IRA.

From a behavioral perspective, most Stretch IRA beneficiaries limit their withdrawals to just their RMD. As a result, their inheritance can last them for decades. I’m afraid that by forcing beneficiaries to withdraw the funds quickly, many will squander the money. There will be a lot of consequences from the SECURE Act. We are here to help you unpack these changes and move forward with an informed plan.