Two HUUUGE Questions About The Biggest Tax Cut In American History

Stock markets rallied this week in anticipation of, and in reaction to, the President’s tax plan. Probably the biggest concern on most people's’ minds has been, "What do I stand to lose?" Meanwhile, policy makers must wrestle with who will  “pay” for tax cut proposals (as much as $7 trillion by some estimates) by closing loopholes. Of course, what may be a loophole to some is considered sacrosanct to others. Even though many important details are still lacking, there do seem to be some answers to the two most common questions I’ve fielded in conversations over the past few weeks.

Will I still get a deduction for making retirement contributions?

Initially, the president’s press secretary, Sean Spicer, was quoted as saying the proposal only included tax deductions for charitable giving and mortgage interest, “that’s it.” Afterwards, he clarified that the plan did NOT include doing away with the deduction for making retirement account contributions. It does make you wonder how close of a decision it was, given the recent report from the Congressional Joint Committee on Taxation showing that about $1.5 trillion in taxes could be raised in the next decade by changing how the upfront tax benefits of those accounts are currently treated.

For now, most retirement account contributions such as your salary deferrals, company matching, profit sharing, etc, are made pre-tax. The growth of the account is then tax deferred until retirement, where the proceeds are taxed upon withdrawal.

One proposal being examined is treating all retirement account contributions in the same manner as Roth IRAs, that is, you would receive no tax break on the front end but you wouldn't pay taxes upon withdrawal either. Believe it or not, arithmetic doesn’t favor paying a certain percentage in taxes sooner versus later.

Consider this simple example. You are in a 25% tax bracket and invest $1,000 for 10 years at 7.2%.

1. Pre-Tax, Tax Deferred:  You put in $1,000, it grew to $2,000, and you owed $500 (25%) in taxes upon withdrawal, leaving you with $1,500.
2. Post-Tax, Tax Free: You put in $750 ($1,000 minus 25% tax), it grew to $1,500, and you owed nothing in taxes, leaving you with $1,500.

Conventional wisdom is that you will be in a lower tax bracket in your golden years, but the more complicated reality is that your tax situation may change by circumstances that can be challenging to control, such as exceeding Social Security taxation levels, having Required Minimum Distributions push you into a higher tax brackets, and/or the potential for higher tax rates in the future driven by the voracious government appetite for spending.

So, yes, your deduction for this year’s retirement contribution appears safe. Even if the upfront tax benefits were to go away, however, it is likely that you would still see significant benefits to continuing your contributions.

Should I wait for capital gains taxes to go down to take a profit?

Depending on your current income tax bracket, long-term capital gains (LTCG) are currently taxed as low as 0% and as high as 23.8%. The White House proposes dropping LTCG rates to a high of 20% by eliminating the 3.8% Medicare surtax that is currently added on to LTCG rates for single taxpayers with adjusted gross income over $200,000 or $250,000 for joint. The House GOP’s, “A Better Way” has proposed reducing the top rate on LTCG even further, to 16.5%.

If you made a $1,000 investment over a year ago that is now worth $2,000, the most you potentially owe in Long Term Capital Gains + Medicare surtax is $238, or about 12% of the overall value of your holding. Even if the GOP’s 16.5% proposed LTCG rate were to become law, your tax burden would only shrink to $165, or to about 8.25% of your holding. Considering that 10%+ stock market corrections occur about once per year, it wouldn’t be surprising (and it may even be likely) that the next dip will cost you more than you would have saved by waiting.

I typically recommend not waiting to liquidate any amount you foresee spending in the next couple of years, regardless of pending tax laws. History suggests that it is likely we will see a swoon or two in that timeframe that could easily exceed any potential tax savings.

Everyone's situation is different, which is why you shouldn’t wait on having a plan in place. Get in touch if yours needs review.

Want More Interest On Your Cash?

Check Your Pockets

Do you know that feeling when you find money in your pocket when doing laundry? So how often do you put the bill back in the wash?

Last year, a GOBankingRates survey showed that an alarmingly high number of Americans have less than $1,000 in savings. While the media rightfully highlighted the savings shortfall in its coverage of the survey, as a financial planner, I wondered how the 30% of us that have more than $1,000 in savings are doing.  

As it turns out, while we may be hard pressed to find someone that would admit to passing on picking up a found $20 bill, it may be far easier to find folks leaving a lot more than loose change at their chosen savings institution.

To confirm my hunch, I started by visiting BestCashCow.com, a site that tracks interest rates at a variety of depository institutions across the country. There I learned that the average interest rate on savings accounts on their site is a whopping 0.13%. This is a cross section of institutions that may be local, on the other side of the country, or online only. What the best paying options on their site have in common is that they offer competitive interest rates significantly higher than the national average while still being insured up to $250,000 per depositor by the Federal Deposit Insurance Corporation (FDIC) or the National Credit Union Administration (NCUA).

Today, there are several banks offering annual percentage yields 8 – 9 times the national average. If you have $100,000 in savings being paid 0.13% APY, you’re earning about $130 per year. Opt instead for one paying 1.15% and see your earnings increase to $1,150 with virtually no risks.

These accounts also fare well against some of the largest mutual fund money markets. A couple of the largest examples are the Fidelity® Money Market Fund (SPRXX) with a current 7 day yield of .76% and the Vanguard Prime Money Market Fund (VMMXX) is at .92%. These are certainly better paying options than the average savings account, but would fall short of the federally insured saving accounts noted in the previous example. Using the 1.15% as a comparison, you would earn $390 or $230 more, respectively, on a $100,000 balance over the course of a year if all the rates stayed the same over that period. 

Just to be clear, I’m not advocating investors rush to pull cash out of their long-term investment portfolios to cash in on interest rates hovering around 1%. However, for those emergency accounts or cash that is earmarked for a specific purpose in the next year or two, it makes little sense to allow your bank or fund company to use the money for less than the market will bear.

What financial institutions count on is you staying with them once you have your assets on deposit. Some may encourage you to put money in by offering you more favorable terms on credit or other offerings if you maintain a deposit account above certain thresholds. Others may entice you with a freebie, like an upfront cash bonus. All of them know that you aren’t likely to want to go through the hassle of opening multiple bank accounts to move funds around as rates rise and fall.

There are even businesses that will shop and move your funds around for you, if you don’t mind paying them some of your pocket change. One that recently sent me a solicitation charges $80 per $100,000 that it "manages" for clients each year. But for ATX Portfolio Advisors' clients, I have a better solution.

1. Open an account wherever you can get the best rate on your cash, give me a call if you would like some help finding the best deal.
2. Link the account through my reporting and communications partner, Blueleaf.
3. I’ll help you manage it by periodically letting you know if there is a better deal elsewhere and facilitating the transfer if you determine it’s worthwhile.

It’s that simple, and there is no extra charge for the service. That’s Fee Only (When You’re Up) Accountable Wealth Management. If you aren’t currently a customer and would like to “test drive” ATX Portfolio Advisors, get in touch and I’ll set you up in Blueleaf for free. It may even be better than finding Alexander Hamilton in your laundry basket.

How to Save For Retirement

Next Tuesday is the deadline for making IRA contributions for 2016. Last year’s Accountable Update on the same subject, Allergies and April 18, explored the “cost” of skipping a contribution. That message is still timely if you have the means to make a contribution beforehand. 

The fact is, however, that "nearly half of families have no retirement account savings at all," the Economic Policy Institute (EPI) reported last year. EPI went on to show that the median retirement savings for all families in the US is less than the maximum IRA contribution for 2016 ($5,500).

While it is a sad reality that some folks just have too much month leftover after the money runs out to put something away, for many it is more about the choices we make. So, this year, let’s look at how making different choices can quickly get you on the right track.

Give A Hand Up

This first tip is for parents and grandparents that have the means to make a gift to your kids and grandkids. While the tax laws require earned income to qualify for making an IRA contribution, there is no restriction on where the funding for the IRA comes from.

For example, my 17-year-old had a summer job last year that earned him about $1,200. For 2016, the rules regarding funding an IRA limit contributions to $5,500 or your taxable compensation for the year, if your compensation was less than $5,500. Thus, my son can contribute up to $1,200 to an IRA for last year.

The problem? He has already spent about half of what he earned. But, I’m willing to match him dollar for dollar if he’ll invest it in a Roth IRA. I have taken time to explain to him the value of investing at such a young age. Showing him a compound interest calculator, like the one on the SEC’s website, allowed him to easily see the benefits of regular savings over time.

We've also discussed that he can expect similar matching "gifts" going forward. I hope this results in an early appreciation for the value of saving and investing by improving his understanding that the real payoff is down the road.

While annual gifting does have limitations ($14,000 per donee in 2016-17), it can also provide a very efficient way to transfer wealth, especially if you anticipate your estate will be above the estate tax thresholds.

Spend What’s Left

Have you ever noticed that no matter how much money you make, it never seems to be enough? Perhaps you are seeing the effects of the psychological phenomenon known as “present bias”. This predisposition to opt for the immediate gratification of making a purchase today ultimately comes at the expense of saving for tomorrow. But knowing that we may have that tendency can allow us to effectively plan to overcome it.

Take for example, tax refunds. In 2015, about 70% of tax returns resulted in a tax refund that averaged nearly $3,000. That would fund over half of an IRA contribution for those taxpayers! Some may suggest paying off debt with your refund, but since retirement contributions are "use or lose" opportunities, I favor paying yourself first while you still can.

In households with < $61,500 Adjusted Gross Income, there is also a tax credit available for up to $1,000 if an IRA or other retirement account contribution is made. The credit is referred to as the Retirement Savings Contributions Credit, and while it may only apply to those with relatively modest incomes, it is a pretty sweet incentive for those that qualify. 

I’ve also previously discussed cash back credit cards and “snowballing” debt payments by paying off your highest interest debt first and then applying those payments to the next highest until the debt is paid off. Taking cash back rewards or extinguished debt payments and putting those into your retirement account can really help in making the shift to saving first and spending what is left. 

Small Changes Add Up

While having Mom & Dad helping foot the bill or getting some cash back from Uncle Sam are great, for most of us the reality is that we have to make occasional hard choices when it comes to saving or spending. Before getting into how a few small changes might add up to significant retirement savings, let’s be honest. Budgets, like diets, get blown by rationalizing. Telling yourself that this “one cookie” won’t hurt anything is probably true, until your “one” turns into several. Suddenly those hundred or so calories are now 400-500 and you're left staring at the scale wondering why those pounds won't come off.

The same thing happens when we grab a bottled water, coffee shop latté, or take-out meal. Not only may some of those add inches to our waist, they all take bites out of our wallets. If we just partake in these indulgences on rare occasion, it’s no big deal. But if we aren’t honest with ourselves and allow them to become habit, they can quickly eat up our potential to save more.

Some ideas of places to look for some savings include:

• Limiting withdrawals at your bank’s ATM to once per month instead of hitting any ATM (especially out of network) every time you need $20. 
• Cook your own dinner or bring lunch instead of eating out.
• Drinking tap water.
• Making your own coffee.
• Dropping that premium cable subscription, or cable altogether.
• Stop paying for gym memberships you aren’t using.
• Keep that old phone a while longer and drop the replacement insurance plan.
• Arrange a work carpool.

As you can see below, these can really add up.

ATM Fees[i]	$4	x4 per month	= $16/month
Eating Out[ii]	$10	x5 per week	= $200/month
Bottled H2O[iii]	$1	x1 per day	= $30/month
Coffee[iv]	$2	x1 per day	= $60/month
Reduce Cable	$50	x1 per month	= $50/month
Cut Gym	$25	x1 per month	= $25/month
Reduce Phone	$25	x1 per month	= $25/month
Carpool [v]	$13	x2 per week	= $54/month
			= $460/month

Everyone’s personal situation will vary, but by employing one or more of the ideas we’ve touched on today, you’ll be well on your way to being one of the good statistics. Get in touch if you have any questions.

[i] http://www.bankrate.com/banking/checking/2016-bankrate-checking-account-survey-atm-fees-stay-on-record-setting-streak/

[ii] http://www.thesimpledollar.com/dont-eat-out-as-often-188365/

[iii] http://www.businessinsider.com/bottled-water-costs-2000x-more-than-tap-2013-7

[iv] http://www.fastfoodmenuprices.com/starbucks-prices/

[v] Based on average commute distance of 12.6 miles each way and IRS mileage rate of $.535 per mile