2020 Year-End Tax Moves

2020 Year-End Tax Moves

 

The Tax Cut and Jobs Act (TCJA) passed at the end of 2017, and the Setting Every Community Up for Retirement Enhancement Act (SECURE) passed at the end of 2019. These both made significant changes to annual tax-planning strategies.

The COVID-19 pandemic and the CARES Act relief package that followed created a new layer of complexity. Unfortunately, many taxpayers miss opportunities for significant tax savings.

Here are six moves to consider making before the end of the year to potentially lower your taxes both this year and in years to come.

  1. Take the Standard Deduction Later. The new tax rules nearly doubled the standard deduction and eliminated many write-offs, limiting the benefit of itemizing deductions for most taxpayers. However, you can optimize your deductions by “bunching” itemized deductions in a single year to get over the standard deduction threshold and then by taking the standard deduction in the following year.

    Example: Instead of giving $10,000 to charity annually (which will likely leave you with the standard deduction anyway), gift $50,000 every 5 years. This will give you a greater tax benefit in the first year while still claiming the standard deduction in the other years to maximize tax savings.

  2. Pre-Pay Your Medical Expenses. Have major medical-related expenses coming up? You can potentially maximize the tax deduction by paying out-of-pocket medical expenses in a single calendar year—either by pushing payments out to the next year or pulling later expenses into this year.

    A surprising number of medical expenses qualify, including unreimbursed doctor fees, long-term-care premiums, certain Medicare plans, and some home modifications.

    Note: Medical expenses are an itemized deduction, so this strategy may be best used with the “bunching” strategy described above, including possibly paying medical expenses in a year you maximize charitable donations.

  3. Give Money to Your Favorite Charity Right Now from Your IRA. If you’re over 70 ½, you can make up to $100,000 of annual Qualified Charitable Distributions (QCDs) directly from your IRA to a qualifying charity. Even better, for retirees who don’t need to take their Required Minimum Distribution (RMD) each year, these qualified charitable distributions count toward the RMD but don’t appear in taxable income.

    Even though the CARES Act allowed RMDs to be skipped in 2020, you can still make a QCD this year.

    Note: QCDs must be made by December 31 to count for this tax year.

  4. Take Advantage of Years in a Lower Tax Bracket with a Roth Conversion. A Roth conversion can permanently lower your taxable income in retirement by converting tax-deferred assets (IRA / 401k) into tax-free assets in a Roth account. It is best to do this in years where you are in a lower tax bracket than you expect to be in the future.

    Annual Roth conversions when in a lower tax bracket are a way to smooth out annual taxes and minimize the amount paid over a lifetime.

    Example: If a taxpayer at age 63 is in the 12% tax bracket, then moving $10,000 from an IRA to a Roth account will owe an additional $1,200 in taxes. That same taxpayer at age 73 may be in the 24% tax bracket due to Social Security, pension, and RMD income they didn’t have at 62. Taking that same $10,000 from an IRA will now result an in additional $2,400 in taxes.

  5. Optimize Your Investment Portfolio to Improve Expected After-Tax Return. Prior to the TCJA, you could write off some fees you pay for investment management. The TCJA did away with that deduction. There are still ways to pay fees with pre-tax dollars that may make sense depending on the types of accounts used.

    Likewise, some investments will be more tax efficient, and other investments will be less tax efficient. Where possible, move the most tax-efficient investments into a taxable investment account and the least tax-efficient investments into a tax-advantaged retirement account. The goal is to determine an ideal overall allocation, even if each individual account has a slightly different allocation.

    Both strategies above can potentially help maximize the after-tax return on investments.

  6. Optimize Your Retirement Contributions. The most important step you can take right now to reduce your taxes this year may be to review how and where you’re making retirement contributions. You may be missing out on critical tax savings (and investment growth) if you’re not optimizing your contributions.

    Potential retirement account strategies people often miss include Solo 401k for self-employed individuals, backdoor Roth contributions, or “mega” backdoor Roth contributions at certain large employers.

 

Everyone’s situation is different, and today’s retirement environment is complex. Working with a financial professional who coordinates with your CPA can help ensure you’re not missing any opportunities to optimize your portfolio and pay less in taxes.

My Journey to Sustainable Investing | An Advisor’s Perspective

My Journey to Sustainable Investing | An Advisor’s Perspective

 

During my senior year in high school, I was invited to go backpacking in Yosemite with the Yosemite Institute. I had been backpacking many times before with my father all over California. We even climbed the tallest mountain in the continental United States (Mount Whitney) when I was 14. I loved the adventure and challenge of backpacking. In those early years, I didn’t realize the importance of being in nature. It wasn’t until the Yosemite trip that our guides taught us about the history of the national parks in the delicate balance between the visitors and the surroundings. They also taught us the importance of taking care of our planet. When my classmates and I stopped in a McDonald’s on the way home from Yosemite, I remember taking the Big Mac out of the Styrofoam container and asking them to reuse it. Back in the 80s, I don’t think climate change was on many people’s radars. Today, the science of climate change makes me want to do everything possible to care for the planet for the generations to come. I’ve always done my part but drew the line when it came to investing sustainably. My thought has always been to maximize returns in my investment portfolio and give charitably to causes that fight climate change.

I just didn’t believe that I’d be able to diversify enough (too risky). I believed that returns would be lower in part due to higher expenses. I also got confused about the differences between being socially responsible and sustainable investing. There are also a lot of acronyms and terminology to understand, such as SRI (Socially Responsible Investing) and ESG (environmental, social, and governance).

The history of Socially Responsible Investing (SRI) goes back as early as Moses in 1500 BC. In more modern times, the 1950s saw the first mutual fund, the Boston-based Pioneer Fund, to avoid “sin” stocks: companies that dealt in alcohol, tobacco, or gambling.

While I don’t love to support alcohol, tobacco, and gambling, my values aim to focus on investments that help the planet. My values seek to focus on the “E” in ESG: the environment. Doing well while doing good.

Sustainability investing is a choice and investors decide whether aligning their investment decisions with their environmental values is right for them.  At Merriman, we believe that, all else being equal, a sustainability investing strategy should generally reward companies for acting in more environmentally responsible ways than their industry counterparts. This belief is in contrast to many other sustainability investing approaches that exclude entire industries regarded as the worst offenders.  Sustainability strategies place greater emphasis on companies considered to be acting in more environmentally responsible ways while also emphasizing higher expected return securities. This approach enables investors to pursue their environmental goals within a highly diversified and efficient investment strategy.

It feels like we have both been on the same journey to the top of the mountain to build a portfolio that focuses on the environment without sacrificing risk-adjusted returns. Merriman recently announced major changes to our values-based portfolio, and I have moved all of my investments into our new portfolio. When I combine a sustainable portfolio with charitable giving, it is one small way to do my part in “leaving no trace behind.” If you would like to learn even more about our approach, you can read “Incorporating Environment and Social Values into Your Merriman Portfolio”.

 

 

 

Why Do I Need A Financial Plan?

Why Do I Need A Financial Plan?

 

If you fail to plan, you are planning to fail. This adage, generally attributed to Benjamin Franklin, is as true for financial planning as it for other endeavors. At Merriman, we want to help clients meet their financial goals. Any successful goal-setting strategy includes a detailed plan. But this plan is not only helpful for increasing chances of success. It is also one method we use to minimize potential failures.

When you first met your advisor, did you start your relationship and immediately hand over your hard-earned resources to their management, or did they put you through a rigorous due-diligence process to develop an agreed-upon plan before moving forward?

While the latter requires a lot more time and energy upfront from both parties, this hard work pays off and makes the relationship more valuable and more productive in the long-term. (Short-term pain, long-term gain). It can especially add value during times of uncertainty or major life transitions, such as retirement. When the unexpected happens, the plan serves as the basis for deciding how to react. Without a plan, it is easy to act impulsively or without fully considering future consequences. A good plan has already taken into account potential pitfalls or trouble spots and has a strategy to overcome them. With a plan in place, you are able to adjust course, if needed, and ultimately still get to your desired outcomes.

At Merriman, we build a plan together from the beginning of our relationship and stress test your resources to determine the likelihood of achieving your most important financial goals. We start with a discovery meeting where we map out all aspects of your life—financial and otherwise—so we can provide a truly customized plan to help you achieve your goals. To make this meeting as productive as possible, we ask that if you have a spouse or partner, have them join us, as the plan we are building together is for the both of you.

As part of our due diligence, we securely collect important items such as tax documents, insurance statements, estate planning documents, paystubs, budgeting and expenses, financial accounts and retirement income statements, and debts, among other information. This may seem like a lot to ask for at the start, but these documents provide clues to potential weak spots in your plan.

Think of it this way: when you meet with a physician for the first time, do they judge your health based solely on your physical appearance, or do they ask tough questions and run a gamut of tests before providing a diagnosis? The collected samples and information serve as the inputs and the test results are the outputs based on the criteria used in the examination. A financial plan can be thought of the same way.

While test results are useful, they are in themselves really just data. We then interpret this data, informed by our education and experience, to provide comprehensive advice on how best to achieve your financial goals.

Why do you need a financial plan? Because in good times and difficult times, a financial plan is your best opportunity to meet your financial goals. At Merriman, that’s our mission, and that’s why we take financial planning as seriously as we do. You should expect the same attention to detail from anyone with whom you choose to work.

Reach out to us to discuss your specific goals and the necessary next steps to achieve them.

 

What Women Need Know About Working with Financial Advisors | Tip #3

What Women Need Know About Working with Financial Advisors | Tip #3

I want to acknowledge that all women are wonderfully unique individuals and therefore these tips will not be applicable to all of us equally and may be very helpful to some men and nonbinary individuals. This is written in an effort to support women, not to exclude, generalize, or stereotype any group.

 

I was recently reminded of a troubling statistic: Two-thirds of women do not trust their advisors. Having worked in the financial services industry for nearly two decades, this is unfortunately not surprising to me. But it is troubling, largely because it’s so preventable.

Whether you have a long-standing relationship with an advisor, are just starting to consider working with a financial planner, or are considering making a change, there are some simple tips all women should be aware of to improve this relationship and strengthen their financial futures.

Tip #3 – Know the Difference Between Risk Aware & Risk Averse

Countless studies have shown that women are not necessarily as risk averse as they were once thought to be. As a group, we just tend to be more risk aware than men are. Why does this matter? First of all, I think it’s important to be risk aware. If you aren’t aware of the risk, you can’t possibly make informed decisions. But by not understanding the difference, women sometimes incorrectly identify as conservative investors and then invest inappropriately for their goals and risk tolerance. Since most advisors are well-practiced in helping people identify their risk tolerance, this is an important conversation to have with your advisor. During these conversations, risk-aware people can sometimes focus on temporary monetary loss and lose sight of the other type of risk: not meeting goals. If you complete a simple risk-tolerance questionnaire (there are many versions available online), women may be more likely to answer questions conservatively simply because they are focusing on the potential downside. Here is an example of a common question:

The chart below shows the greatest 1-year loss and the highest 1-year gain on 3 different hypothetical investments of $10,000. Given the potential gain or loss in any 1 year, I would invest my money in …

Source: Vanguard           

A risk-aware, goal-oriented person is much more likely to select A because the question is not in terms they relate to. It focuses on the loss (and gain) in a 1-year period without providing any information about the performance over the period of time aligned with their goal or the probability of the investment helping them to achieve their goal. A risk-averse person is going to want to avoid risk no matter the situation. A risk-aware person needs to know that while the B portfolio might have lost $1,020 in a 1-year period, historically it has earned an average of 6% per year, is diversified and generally recovers from losses within 1–3 years, statistically has an 86% probability of outperforming portfolio A in a 10-year period, and is more likely to help them reach their specific goal.

A risk-aware person needs to be able to weigh the pros and cons so when presented with limited information, they are more likely to opt for the conservative choice. Know this about yourself and ask for more information before making a decision based on limiting risk.

Having a conversation about your risk tolerance, the level of risk needed to meet your goals, and asking for more information is always easier when you follow tip #1—work with an advisor you like. There are many different considerations when hiring an advisor: Are they a fiduciary? Do they practice comprehensive planning? How are they compensated? What is their investment philosophy? They may check off all your other boxes, but if you don’t like them, you are unlikely to get all you need out of the relationship. If you’re looking for an advisor you’re compatible with, consider perusing our advisor bios.

Be sure to read our previous and upcoming blog posts for additional tips to help women get the most out of working with a financial advisor.

Why You Should Consider ROTH Conversions During a Bear Market

Why You Should Consider ROTH Conversions During a Bear Market

 

 

We expect most people have a grasp on how to make money in a bull market, but it can be far more challenging to contemplate how to make money during a bear market, when emotions are running high.  It’s not all about making money, though.  Some of it involves figuring out how to put oneself into a better financial position for the future so that you can heal faster from the losses.  There are a handful of key strategies to engage in during a bear market that will help your finances as much as your future, and one of the most important of these is ROTH conversions.

Believe it or not, bear markets represent the best environment into which to make an IRA-to-ROTH conversion.  The more negative the equity losses are, the more attractive the conversion becomes.  When making a conversion to ROTH, you can either move cash or you can move shares of the stocks or mutual funds that you own in the IRA.  When we make a conversion, we choose to move shares for our client families.  The tactical benefit here is that we actually get to pick the specific funds to move from the IRA to the ROTH.  Whichever funds have the deepest losses for the given year are the ones with the highest priority to move over first.

Think of it this way: if we found ourselves in a sharp bear market, we would expect several equity asset classes to be down, but maybe inside our IRA the US small cap fund went down the most with a -35% loss.  Although it may not feel like it, bear market losses are temporary, so it is important to take action and make the conversion to the ROTH while the markets and the news are negative and remain temporarily distressed.  If we were to hypothetically move $50,000 of the US small cap fund in our example, we would actually be moving shares that were previously 35% higher in value at $77,000.  If we convert the $50,000 of small cap shares right now, we incur the tax liability on those shares on the day they are moved over.  Once the shares have arrived in the ROTH, it then becomes a matter of exercising patience.  It might take six or nine months for the current bear market to pass; but when the economy improves, those distressed shares should bounce back in value.  In a relatively short number of months, the $50,000 that was converted and that you paid tax on might be worth $65,000 or $70,000—but remember, you only paid tax on $50,000.  Much like a spring being compressed and then subsequently released, the idea behind the conversion is to move the shares to the ROTH while the spring is compressed.  Simply put, the bear market represents a tax-savings opportunity in disguise, so acting now is highly important BEFORE things improve in society.  Effectively, ROTH conversions and bear markets coupled together give us a way to legally cheat the IRS out of tax dollars.

The benefits of ROTH conversions are not just effective during a severe bear market but can be utilized nearly every year.  If you employ a highly diversified portfolio with multiple asset classes held in your IRA and ROTH, there are lots of opportunities to take advantage of the up and down stock market movements, as many asset classes move at different rhythms.  There are a host of financial planning advantages to ROTH accounts and gradually converting IRA money into ROTH each year.  Keep in mind, ROTH accounts contain post-tax money; they do not have required minimum distributions, which do apply to traditional IRAs; and all of the future growth on the assets in the ROTH are considered post-tax.  All withdrawals from ROTHs are voluntary, and all of the dividends, interest, and earnings in the ROTH are shielded from taxes.  Another advantage of a ROTH account is that it can be viewed with your IRA using an overall investment approach that we call Asset Location.  Essentially, Asset Location seeks to view the IRA and ROTH accounts as if they were one account holding one investment portfolio but divvies the funds between the accounts to the greatest advantage.  Reach out to your advisor if you are curious about conversions and ROTH accounts and learn more about how we advocate for our families.

What Women Need to Know About Working With Financial Advisors | Tip #2

What Women Need to Know About Working With Financial Advisors | Tip #2

 

I want to acknowledge that all women are wonderfully unique individuals and therefore these tips will not be applicable to all of us equally and may be very helpful to some men and nonbinary individuals. This is written in an effort to support women, not to exclude, generalize, or stereotype any group.

 

I was recently reminded of a troubling statistic: Two-thirds of women do not trust their advisors. Having worked in the financial services industry for nearly two decades, this is unfortunately not surprising to me. But it is troubling, largely because it’s so preventable.

Whether you have a long-standing relationship with an advisor, are just starting to consider working with a financial planner, or are considering making a change, there are some simple tips all women should be aware of to improve this relationship and strengthen their financial futures.

Tip #2 – Tell Them What You Want

Studies have shown that women tend to be more goal-oriented than men. I have found it to be true that women are more likely to focus on goals like maintaining a certain lifestyle in retirement, sending children to college, or making sure the family is protected in the event of an emergency, while others may focus more on measuring investment performance.

At Merriman, we believe all investing and financial planning should be goal-oriented (hence our tagline: Invest Wisely, Live Fully), but many advisors still set goals that focus on earning a certain percentage each year. This can be especially difficult if your partner focuses on this type of measurement as well. Women (or any goal-oriented investor) can sometimes feel outnumbered or unsure of how to direct the conversation back to the bigger picture. You made 5%, but what does this mean for your financial plan? Can you still retire next year? The issue is not that you don’t understand performance or lack interest in market movements, whether or not this is true. The issue is that the conversation needs to be refocused on the things that matter to you. All of the truly excellent financial planners I have worked with have known this and do their best to help clients identify their goals, create a plan for obtaining them, and then track their progress. If you’re not experiencing this, it’s either time to look for a new advisor or to speak up and tell them what you want. Also, note that speaking up is more easily done when you work with an advisor you like (see tip #1).

There are many different considerations when hiring an advisor: Are they a fiduciary? Do they practice comprehensive planning? How are they compensated? What is their investment philosophy? They may check off all your other boxes, but if you don’t like them, you are unlikely to get all you need out of the relationship. If you’re looking for an advisor you’re compatible with, consider perusing our advisor bios.

Be sure to read our previous and upcoming blog posts for additional tips to help women get the most out of working with a financial advisor.