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Taxes

The American Families Plan – the Good, the Bad, and a lot of Debt

By | 2021, Money Moxie, Newsletter | No Comments

The U.S. middle class is shrinking. There has been growing polarization as the rich become richer and the poor become poorer. The Biden administration is proposing the American Families Plan to be a “once in a generation investment to rebuild the middle class and invest in America’s future.”1 Here are some of the key points and their potential impact if the plan is enacted.

Making Education Affordable
The Biden administration plans to make education more affordable and expand opportunity. It is proposing two free years of community college and lower costs for minorities to attend college or a university. The amount of Pell Grants may increase. There could also be universal access to free pre-kindergarten (preschool).

Providing Economic Security for Families
The goal is to make it easier for everyone to have “the opportunity to join the workforce and contribute to the economy.” The plan does this by ensuring that no one earning under 150% of the state median income pays more than 7% of their income on high-quality care for children. The plan also provides paid family and medical leave to care for a new child or for a serious illness.

Expanding Tax Credits to Help Workers and Families
The plan uses tax credits to transfer wealth to those with lower income. It proposes tax credits of up to $8,000 to cover childcare expenses for a family with children under age 13 who make under $125,000. The income phase-out moves from $125,000 to $438,000. The plan also increases child tax credits for the next 5 years from $2,000 per child to $3,600 for children under age 6 and $3,000 if over age 6. It also makes permanent the earned income tax credit for low-income childless workers.

Impact
As with all legislation, there would be good, bad, and unintended consequences. We do need a workforce educated for our modern economy. Education is a key to opening opportunities.

Families with children stand to benefit, especially low-income families who would gain access to childcare.

There is some concern that the administration “strongly prefers getting kids out of the home and parents into the workforce.” There is also a concern that “too much focus on federal mandates might be detrimental to the effects on children who otherwise might be raised with the involvement and investment of a parent.”2

Taxes are another concern. Right now, the administration is only planning tax hikes for high-income earners, investors, and corporations. Additionally, the administration is planning an infrastructure spending bill. We are facing a massive national debt that is at $28 trillion and may reach $89 trillion by 2029.3

Social Security and Medicare also have to be fixed. There isn’t a way to tax the “wealthy” enough to account for all of the government spending. As taxes go up, the economy may slow. This could be the unintended consequence that we fear.

Most people agree with the stated goals of this plan: providing education and opportunity. We want to help families have financial security. The challenge is paying for these programs. It will remain to be seen what the final impact is on the economy, the lower and middle classes, and the family as the fabric of society.

1 https://www.whitehouse.gov/american-families-plan/
2 https://www.ksl.com/article/50168776/mitt-romney-i-didnt-realize-i-was-at-a-disadvantage-because-my-mom-stayed-home
3 https://www.forbes.com/sites/mikepatton/2021/05/03/us-national-debt-expected-to-approach-89-trillion-by-2029/?sh=5bd9292a5f13

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Getting Organized

By | 2021, Money Moxie, Newsletter | No Comments

Keeping up with paperwork, documents, and bills each year can be challenging. It is too easy to put the papers in a pile to be addressed at a future date. Or, my personal favorite, file them away and store them until you run out of space.

You can handle paperwork more efficiently. The tricks are to go paperless when possible and save only necessary documents. Technology makes it easy to organize statements and bills, so take advantage of electronic access whenever possible. Some documents like pay stubs, investment statements, and insurance policies may be kept for a year. Other documents will be around longer. Suggestions for what to keep and what to toss are summarized below.

For tips on organizing your entire home, watch our recorded Money Matters webinar. It can be found on our website at SmedleyFinancial.com under Just for Women – Organization from March, 9th, 2021.

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Taxing Times

By | 2021, Money Matters, Newsletter | No Comments

It is that time of the year! Tax season is upon us. As you gather your tax documents together, you may be wondering how you are taxed on investments. This is a good time to review how taxes apply to different account types.

Tax-deferred

Most everyone has some type of tax-deferred account, generally thought of as a retirement account(s). Money is invested in these accounts before taxes are paid. It grows over the years and is taxed when you take it out of the account through withdrawals and distributions. These accounts include Individual Retirement Account (IRA), 401(k), 403(b), SIMPLE IRA, SEP IRA, etc. It can also include non-qualified tax-deferred annuities where the initial investment has been taxed, but the tax on the growth is deferred until you take a withdrawal from the account.

Money taken from tax-deferred accounts is taxed as ordinary income. That means it is taxed at your marginal-income tax rate.

Restrictions apply to these accounts. For instance, the amount of money you can invest each year is limited based on the account type and your age. If you take money out before you are age 59 ½, you will pay an early withdrawal penalty of 10%. Furthermore, you must begin taking money out of these accounts by age 72. This is known as a Required Minimum Distribution (RMD), and you will be subject to a penalty if you miss the deadline.

Taxable

Taxable investment accounts can be accessed at any time without restriction. They are often used to reach a specific goal or increase savings that will be used to supplement income during retirement. The initial investment has already been taxed, and you will only pay tax on the growth.

The tax rate is determined by the length of time you hold the investment. If you hold a specific investment within a taxable account for more than one year and one day, you will be taxed at lower capital gains rates. If you sell an investment in less than one year, taxes are calculated at your ordinary income-tax rate. Dividends received are generally taxed as ordinary income as well.

You can manage taxes within the account by offsetting gains and losses. This strategy can be helpful in reducing taxes.

You are free to add as much money as you want to a taxable account, and there are no requirements to take money out of this type of account regardless of your age.

Tax-free

Growing money without taxes is a wonderful way to plan for retirement. This can be done in a Roth IRA or Roth 401(k). Money is invested in the account after taxes have been paid. Any growth earned over the years is tax-free. It does not get better than that!

There are differences between the two types of Roth accounts. The amount of money you can contribute is limited by the type of account and your age. A Roth IRA has no required distribution date. You can leave the money in the account until you are ready to use it or pass it to your heirs tax-free. Unfortunately, the Roth 401(k) is subject to Required Minimum Distributions at age 72. This can be avoided by rolling the Roth 401(k) to a Roth IRA before the year you will turn 72.

For details on marginal tax rates, capital gains rates, and contribution limits, visit us at SmedleyFinancial.com and browse the updated 2021 tax information. You can also call us at 800-748-4788. Happy tax season!

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What does a Biden presidency mean for the economy and investing?

By | 2021, Executive Message, Money Moxie, Newsletter | No Comments

The recent election has some people elated and others in the depths of despair. While we don’t focus on the political ramifications, we can consider some of the financial impacts that may come. There is no guarantee that any of these will happen, but here are some possibilities:

We get more stimulus: In the short-run, this is a great thing for our economy and the market. There are too many Americans and businesses that are still struggling and need help to get through this pandemic. The long-term challenge is how to pay down the government debt.

Taxes go up: Even before the election, we knew that taxes needed to go up because of the massive amount of government debt. We have been at historically low tax rates. While tax rates seem unlikely to go up soon, don’t plan on them staying this low forever. Depending on your situation, you may want to realize taxation of some assets now to avoid paying taxes in the future. Consult with your financial and/or tax advisor.

Interest rates go up: They will probably still stay low for a while (i.e. 1-2 years). However, they will probably start going up after that. Increasing rates are good for savers and bad for borrowers. CD’s may pay a decent rate in the future, but affording a home will get harder.

Investing in ESG goes up: ESG stands for Environmental, Social, and Governance, also known as sustainable investing. With the Democrats in power, companies that are ESG friendly should get a boost. Examples of companies that will benefit include green energy, health and safety, and companies that promote diversity.

The economy will grow: The economy will probably start to recover quickly at first as we accelerate out of the global pandemic. However, growth will probably be slowed down by taxes and inflation after that, but it will still go in the right direction.

The market may go up: In the long-run, this is certainly likely. Over the coming months, the market could go up because of the recent stimulus and the prospect of more stimulus. A great deal of this money is likely to go directly into investments, while some will boost the economy through spending.

There may be some softness after that. But, as the economy fully recovers from the global pandemic, the market should continue its march higher. The market has shown that it doesn’t matter which political party is in power. It still does what it is going to do.

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Year-End Tax Planning

By | 2020, Money Moxie, Newsletter | No Comments

Harvest losses now to help your next tax return
If you have investments that have gained money this year and others that have lost, you can sell some of both in order to reduce the tax liability when you do your taxes next year. This is known as tax-loss harvesting. You can consult with Smedley Financial and/or your accountant to see how to best maximize your tax situation.

Qualified Charitable Distributions
If you are over age 70 ½ and are charitably inclined, then you still have time to do a Qualified Charitable Distribution or QCD. This year you don’t have to take a Required Minimum Distribution (RMD), so many people are considering not doing their QCD as well. However, we are still concerned the tax rates may go up in the future, so we would like to get as much money out of IRAs as possible tax-free. If you are going to make charitable donations anyway, a QCD is still a great option.

Convert your IRA to a Roth IRA
You can reduce future tax liabilities and take advantage of the current favorable tax environment by converting all or a portion of your tax-deferred retirement account to a Roth IRA. The conversion must be completed before December 31st. You can also use this strategy to maximize a low tax-bracket. For example, if you are married filing jointly, and your taxable income is $30,000, you can increase your taxable income to $40,125 and remain in the 12% tax-bracket. To get the full value of the conversion, plan to pay the taxes on the conversion from another account, such as a savings account.

Donate appreciated stock
If you have appreciated stock in your portfolio, you can donate the stock to a charity and avoid paying tax on the gain. Even better, if you itemize your taxes, you can receive a deduction for the value of the stock on the day the donation is made. One catch: you must have owned the stock for over one year before making the donation. Then you can invest the cash you would have donated to make a future donation.

Bunching deductions
The number of tax filers using the standard deduction has increased over the last couple of years. This is because the standard deduction was increased to a level that exceeds most filers’ tax deductions. However, if you are close to the standard deduction, you might consider bunching deductible items into one tax year. For example, you can make charitable donations for two years at a time or push medical expenses into one year. Then you can itemize every other year.

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Supersized Retirement Savings

By | 2020, Money Moxie, Newsletter | No Comments

If you want to supersize your retirement savings for early retirement or help you make up for lost time, consider a mega backdoor Roth. It can allow you to stash up to another $37,500 into retirement savings, which will grow tax-free. In an environment where taxes may go up because of government debt, this can be a very worthwhile proposition. It is especially beneficial for earners that make too much to contribute to a regular Roth or have too much in IRA assets to do a regular backdoor Roth. Of course, there are hurdles and restrictions.

The first hurdle is maxing out your 401(k) or Roth 401(k) contributions. In 2020, the limit is $19,500, or $26,000 if over age 50. If you aren’t contributing enough to hit these thresholds, then a mega backdoor Roth doesn’t apply. If you are hitting these thresholds, then your normal contributions should probably be pre-tax, and the backdoor Roth can serve as your after-tax savings. (It may not make sense to put all of your contributions into the Roth bucket if you are taxed at 37% federally.)

If you earn less than $124,000 or $196,000 filing jointly, then you are still eligible to contribute to your normal Roth IRA. Make that contribution first, which can be $6,000 or $7,000 if over age 50. If you earn more than the limits, then a mega backdoor Roth is your only retirement savings option.

The next big hurdle is your 401(k) plan. Only 43% of companies allow for after-tax contributions. In addition, the company 401(k) plan needs to allow for in-service distributions into the Roth. If the plan checks both of these boxes, then the contributions go into the after-tax portion, and the plan administrator can convert those assets into a Roth.

If the plan doesn’t allow for in-service distributions, then you can still put money in after-tax, but the earnings will only be tax-deferred. Usually at age 59½ or at retirement, you can place the after-tax portion into a Roth IRA, and the tax-deferred portion can go into a traditional IRA. This somewhat defeats the purpose as the goal is to get as much as possible into a Roth as soon as possible to allow for tax-free growth.

If you have jumped over these hurdles, then you are ready to stash money away. In 2020, you can put a maximum of $57,000 into a retirement plan, including your contributions and the company’s match. So, if you put in $19,500, and the company matches $5,500, then you can put in up to $32,000 more in the mega backdoor Roth. Talk about supersizing your retirement savings!

The major benefit of a mega backdoor Roth over a regular backdoor Roth conversion is not having to deal with the pro-rata rule. In a normal backdoor Roth, whatever you convert is proportionate across all of your IRAs. So, if you have any sizable amount in pre-tax IRA (i.e., traditional IRA), then you have to convert and pay taxes on the proportional amount converted from the IRA. Depending on the size of your IRA, and if you are under age 59½, this can really hurt. Since the mega backdoor Roth takes place in a 401(k), that pro-rata rule doesn’t apply.

While there are hurdles and restrictions, the mega backdoor Roth can be a great way to supersize your retirement savings. If you have any questions on how this can help you reach your goals, please contact our Private Wealth Managers.

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The Pendulum Swings

By | 2020, Executive Message, Money Moxie, Newsletter | No Comments

There is a giant pendulum that swings ever so slowly. When it gets to one extreme, the gravitational force pulls it back the other direction. Because of the Great Depression and World War II, the pendulum of national debt rose to an astounding 106% of GDP* in 1946.1 The pendulum took until 1974, or 28 years, to swing the other direction and get down to 23% of GDP.

With the back-to-back economic crises of the Great Recession in 2008 and COVID-19 in 2020, the debt to GDP ratio has swung dramatically back in the wrong direction. We now sit at 100% debt to GDP with a projection to get to 106% of GDP by 2023.2

What will be the long-term impact? Undoubtedly, taxes will go up. I recently heard it said, “The politicians that are telling you they can cut taxes are just bad at math.” If you look at history, tax rates shot up to 94% in 1944 for the highest tax bracket.3 That’s right, 94%! This was done with more marginal tax brackets. There were 24 brackets back then compared to just 7 today.

In 1965, the highest rate declined to 70%. It stayed around there until 1982 when the highest rate became 50%. Currently, our highest tax bracket is 37%.

I’m not a doomsday predictor. I don’t believe a new tax bracket will send rates up to 94%. However, I do worry about taxes going up for almost everyone. You can’t tax the “rich” enough to cover the current deficit and make the pendulum swing the other direction.

Thankfully, I believe there are prudent tools we can use to help protect you against future taxes. If you aren’t retired, you can contribute to a Roth IRA or Roth 401(k), depending on your income. If your income is below $139,000 (single) or $206,000 (married), consider a Roth conversion from your IRA or 401(k). If you are over age 70½, you can make tax free donations to a charity from your IRA.

These are just a few options to help protect against future taxes. For our clients, we will continue to review your personal financial plan to make sure you are prepared for the future regardless of what may come. If you want to schedule a review appointment, please contact us.

*GDP or Gross Domestic Product is the total output of the economy for one year. SFS and its representatives do not provide tax advice; it is important to coordinate with your tax advisor regarding your specific situation.
(1) https://www.washingtonpost.com/opinions/2020/05/27/this-is-not-your-grandfathers-debt-problem/
(2) https://www.bloomberg.com/graphics/2020-debt-and-deficit-projections-hit-records/
(3) https://fred.stlouisfed.org/series/IITTRHB

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A Neglected Tax-Saving Strategy: Qualified Charitable Distributions

By | 2020, Money Moxie, Newsletter | No Comments

There are two types of people who complain about paying taxes, men and women. We all recognize the importance of taxes, but Gerald Barzan said it best, “Taxation with representation ain’t so hot either.” Yes, tax evasion is illegal, but tax avoidance…that’s wisdom. Tax avoidance should also be a financial advisor’s specialty. This is precisely why I’m so surprised by the number of financial and tax professionals who are unfamiliar with, or do not utilize, the Qualified Charitable Distribution.

The Qualified Charitable Distribution, or QCD, is a powerful tax savings strategy available to individuals age 70.5 and older who donate to 501(c)(3) organizations. Examples of 501(c)(3) organizations include religious, educational, and scientific organizations, public charities, and private foundations.

When you take a distribution from a tax-deferred retirement account, the distribution will be taxed at your marginal tax rate. However, if the distribution is from an Individual Retirement Account (IRA) and is sent directly to a 501(c)(3) organization, it qualifies as a QCD and becomes tax-free.

For example, Elliott has a required minimum distribution from her IRA of $3,000. Her tax rate is 20% federal and 5% state. Elliott plans to donate $3,000 to a 501(c)(3) organization this year. If Elliott takes the $3,000 distribution and pays the tax, she’ll receive $2,250 from her IRA. When she makes her $3,000 donation, she will be $750 short.

However, Elliott has a wise financial advisor who tells her about the QCD. So, she sends her $3,000 IRA distribution directly to the charity, and Elliott doesn’t pay tax on the distribution at all. Elliott’s required minimum distribution is satisfied for the year, she donates the desired $3,000 to charity, and her wise financial advisor saved her $750 in taxes.

Every year, we educate financial and tax professionals regarding the QCD and how to report it on the form 1040. Too often, we see it reported incorrectly. If you make a QCD and do not report it accurately, you won’t receive the benefit. If Elliott or her CPA doesn’t understand how to report her $3,000 QCD, she’ll pay an extra $750 to the IRS, and the QCD won’t save her anything.

On tax form 1040, line 4a asks for “IRA distributions,” and line 4b asks for the “taxable amount” as shown below.

Elliott took a $3,000 distribution from her IRA and will write $3,000 on line 4a. She will then subtract her QCD amount from 4a and write the balance on line 4b. In Elliott’s case, she will write $0 on line 4b, and no tax will be due from her IRA distribution. A tax penny saved is a tax-free penny earned.

Please help us get the word out regarding the Qualified Charitable Distribution. If you, your CPA, or your friends have questions about QCDs or other tax-saving strategies, please contact us. Tax planning is our specialty, and tax avoidance is the goal.

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Year-End Tax Strategies

By | 2019, Money Moxie, Newsletter | No Comments

We are closing in on the holiday season. Before you slip into the holiday mode, let’s talk about a few ways you can wrap up the year!

1. The market has had an incredible run. This is an excellent time to look at your non-retirement accounts to see if you can take advantage of tax harvesting.

If you have an investment that has gained $10,000 and another that has lost $10,000, you can sell both investments and avoid paying tax on the capital gains. This matching of gains and losses is known as tax harvesting.

The gains and losses do not have to match exactly, but your gain and loss have to both be long term or short term. If you have held an investment for more than a year, it is considered a long-term capital gain and would be taxed at capital gains rates. If you have held the investment for less than one year, it is considered a short-term gain and would be taxed at the higher ordinary income tax rates. Either way, the resulting tax savings can be significant.

2. Here’s a win-win strategy. If you don’t have losses to offset your gains, you can still get tax relief by donating to a cause about which you are passionate or your favorite charity: church, school, food bank, hospital, etc. Consider this – donating an appreciated investment directly to your charity of choice will avoid taxes.

To qualify, you must have held the investment for more than one year, and it must have appreciated in value. You avoid paying taxes, and the charity receives the full value of your donation tax-free. The money you would have donated can be used to purchase another investment to start the process over again.

3. Current tax rates are at historic lows. Consider converting money from a traditional IRA to a Roth IRA. You can choose how much to convert. For example, if you have room for another $10,000 of income before you hit the next marginal tax-bracket, make it count.

Before the year ends, convert $10,000 from your traditional IRA to a Roth IRA. If you are under 59 1/2 years old, you will have to pay tax on the conversion with other money – say from a savings account. If you are over 59 1/2, you can have taxes withheld from the distribution.

The benefits of Roth IRAs are tremendous. Roth IRAs grow tax-free, meaning you never pay taxes on the earnings, there are no required distributions at any age, and if you do not use the money during your lifetime, your beneficiaries receive the money tax-free!*

4. If you are over 70 1/2 years old and you have an IRA, you can donate part or all of your Required Minimum Distribution (RMD) to your favorite charity and pay no taxes. This distribution is called a Qualified Charitable Distribution (QCD). The distribution still satisfies your RMD. This cannot be done from a 401(k). If you have a 401(k) and want to take advantage of this next year, you need to roll out your 401(k) before the end of the year.

*Tax-free withdrawals if certain conditions are met: a five-year account aging requirement and attaining age 59½, becoming disabled, using up to $10,000 to buy a first home, or upon death. SFS and its representatives do not provide tax advice; it is important to coordinate with your tax advisor regarding your specific situation.

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Tax Scams Oh My!

By | 2019, Money Moxie, Newsletter | No Comments

The tax season is upon us, and there is no shortage of nefarious individuals looking to make money. Here is a list of potential scams to watch out for–not only during tax season but all of the time:

(1) Phishing emails – these are typically unsolicited emails sent to you posing as legitimate IRS emails. They may contain links taking you to fake websites that ask you to provide personal information. The IRS will never initiate contact with you via email or social media.

(2) Phone – beware of individuals calling and claiming they’re from the IRS. They may threaten you that you owe money and that you will be arrested. They may even say you are entitled to a large refund from the IRS.

Don’t be fooled if the Caller ID on your phone even says the IRS. They can spoof that information. These bad guys are that good. Don’t give them any information. Reach out to the IRS for assistance at IRS.gov.

(3) Tax return preparer fraud – during tax season these scammers pose as legitimate tax preparers. They often promise unreasonably large refunds. They take advantage of unsuspecting taxpayers by committing refund fraud or identity theft.

(4) Fake charities – scam artists sometimes pose as a charity in order to solicit donations. Often these appear after a natural disaster hoping to capitalize on the tragedy.

(5) Tax-related identity theft – this happens when an individual uses your Social Security number to claim your refund. This may not even be discovered until you try to file your return. The IRS may even send a letter to you indicating that they’ve identified a suspicious return.

If you or a loved one has been a victim of identity theft, the Identity Theft Resource Center offers free help and information to consumers at idtheftcenter.org.

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