Tax Planning Tools and Techniques

With 2022 income tax season well underway and almost three months already passed in 2023, now is an appropriate time to review some evergreen tax planning tools and techniques.

 

I recently attended a NY Public Library webinar about tax planning and below is a summary:

 

Standard Deduction- 2023 saw the largest ever automatic adjustment to standard deductions since indexing was introduced in the 1980s. For example, for married couples, the standard deduction is $27,700 in 2023 vs. $25,900 in 2022 and for individuals $13,850 vs. $12,950. A larger standard deduction means that taxpayers can shelter more income from income taxes.

 

Itemizing Deductions- Only about 10% of taxpayers have sufficient tax-deductible expenses totaling more than the standard deduction. Given the $10,000 cap for state and local taxes, three major areas remain for itemization purposes: mortgage interest, charitable donations, and medical expenses (e.g., an elective surgery) that exceed 7.5% of adjusted gross income.

 

Charitable Gifting- Two methods for consideration to make tax-advantaged charitable gifts are donor advised funds (DAFs), to receive an immediate charitable contribution deduction for the tax year the gift was made, and qualified charitable distributions (QCDs) after age 70½ which counts toward satisfying the current year’s required minimum distribution (RMD).

 

Capital Losses- Due to how capital gains and losses are computed, capital gains (short- or long-term) can be offset by capital losses using an ordering method. It is best to have long-term gains outweigh short-term gains, as the latter are taxed at ordinary tax rates up to 37%. Long-term gains are taxed at rates of 0%, 15%, and 20%, depending upon total taxable income.

 

Income and Expense Shifting- Business owners, including employees with “side hustles,” can shift income to the next tax year by postponing client invoices until after December 31. If they want to increase expenses to lower net income to reduce business-related taxes, they can prepay expenses such as rent, lease payments on business vehicles, and business insurance premiums.

 

Retirement Savings Plans- Maximum contributions for 2022 in traditional IRAs and 401(k)/403(b)/457/TSP retirement savings accounts are $6,000 and $20,500, respectively, for workers under age 50. In 2023, these limits are $6,500 and $22,500, respectively. Workers age 50 + can save up to $7,500 in IRAs and up to $30,000 in employer savings plans in 2023. Taxpayers with earned income can make 2022 IRA contributions until the tax filing date of April 18, 2023. Contributions cannot be larger than their reported taxable income.

 

Roth IRAs- Income limits apply to qualify to make a contribution. In 2022, modified adjusted gross income (MAGI) must be under $144,000 for individuals and $214,000 for married couples filing jointly (mfj). In 2023, those income limits are $153,000 and $228,000 (mjf), respectively. A “back-door IRA” can get around this: people make a non-deductible traditional IRA contribution first and, a short time later, convert their balance to a Roth IRA.

 

A key take-away? Proactive planning can save money. Start planning for 2023 taxes today.

This post provides general personal finance or consumer decision-making information and does not address all the variables that apply to an individual’s unique situation. It does not endorse specific products or services and should not be construed as legal or financial advice. If professional assistance is required, the services of a competent professional should be sought

Annuity Myths and Facts

An annuity is a contract between an investor and a life insurance company. Annuities are sold by insurance agents, stock brokers, and other financial advisors. The annuitant, who is usually (but not always) the owner of the annuity, pays a lump sum amount or makes deposits over time and the insurance company promises immediate payments or payments at a future date.

Below are some key things to know about annuities from a recent seminar that I attended:

 

Complexity- Annuities are often sold as a “simple” investment but, in reality, they can be quite complicated. Annuity salespeople sometimes convince people there are no fees but, of course, there are. Examples include surrender charges, sales commissions (loads), management fees, and mortality charges.

 

No Federal Insurance- There is no federal government insurance for annuities as there is for bank products (FDIC) and investment products (SIPC). Therefore, credit quality of issuing insurance companies is very important. Look for an issuer that is highly rated by at least two insurance company rating firms (e.g., A.M. Best, Duff and Phelps, and Standard and Poor’s).

 

Three Types-Fixed annuities are like CDs, only tax-deferred, and guarantee a certain interest rate for a specified time period. Variable annuities are like mutual funds, only tax-deferred, and their owners select underlying mutual funds, called subaccounts, which determine an annuity’s performance. Equity-indexed annuities tie a portion of their return to a stock market index such as the Standard and Poor’s 500. Generally, variable annuities have the highest fees.

 

Two Time Categories- Immediate annuities begin payment within a year of purchase. They are often bought with money from settlements, investment accounts, and pension plan lump sum distributions. Deferred annuities make payments at a future date and allow annuitants time to make deposits. Either type provides a guaranteed income stream subject to contract terms.

 

What Not to Do- Annuities are generally not appropriate for qualified retirement plans such as 401(k)s or IRAs. They are already a tax-deferred product and investors gain no benefit by placing them in a tax-deferred plan. In addition, many annuities have high expenses, making them a less attractive alternative to low-cost investments such as index funds and ETFs.

 

Income Taxes- Earnings on annuities are tax-deferred until annuitants make a withdrawal, generally during retirement. At that time, withdrawals are taxed as ordinary income, minus the amount of after-tax dollars originally used the purchase the annuity.

 

Reasons to Purchase- The attorney presenter noted the following reasons to consider an annuity as part of overall estate and financial plans: 1. Medicaid planning, 2. To convert life insurance policy cash value into income and stop making premium payments, 3. For a guaranteed lifetime income stream, and 4. To dole out money to a spendthrift adult child.

 

In summary, annuities are a financial tool to consider...when they make sense. 

Look for highly rated, low-expense vendors.

This post provides general personal finance or consumer decision-making information and does not address all the variables that apply to an individual’s unique situation. It does not endorse specific products or services and should not be construed as legal or financial advice. If professional assistance is required, the services of a competent professional should be sought.

New Ways to Shop

U.S. Shopping History

Back in the day, people shopped in a single general store in rural towns across America. Think Oleson’s Mercantile store in Little House on the Prairie. Mark-ups were generally high and product selection was limited. This started to change in the late 1800s with the introduction of mail order catalogs (e.g., Sears) where shoppers could select from a wide range of merchandise.

Then came the heyday of large shopping malls in the mid-20^th century. Malls were where baby boomers (me included) went to shop and “hang out.” These malls generally had 4-5 large “anchor” department stores, as well as dozens of small specialty shops. Many were two stories with escalators. It is projected, however, that up to 25% of U.S. malls could close in the next five years. COVID-19 accelerated a decline in shopping malls that was already underway.

The Rise of E-Commerce

E-commerce has emerged as the leading way that Americans shop and Amazon’s share of the U.S. ecommerce market is almost 60%. Almost 1 in 3 Americans (especially Millennials) has an Amazon Prime membership and prime members spend over $1,000 a year. 

Even people who don’t shop that much online often use Amazon and other online retailers to do price checks and/or negotiate with “brick and mortar” retailers. Amazon Prime Day is now the most profitable retail shopping day…more than Black Friday and Cyber Monday combined.

Social Media and Shopping

Beyond Amazon, technology has impacted shopping in other ways. Social media is a big driver of consumer purchases. One example, according to a webinar by Next Gen Personal Finance (NGPF), is so-called “haul videos.” These are videos where social media influencers highlight fast fashion brands to millions of followers. 

Haul videos and the resulting FOMO (fear of missing out) and YOLO (you only live once) mindset that occurs can cause people to blow their budget, over-consume, increase credit card debt, and waste money on low-quality clothing.

Buy Now, Pay Later

Another pandemic-accelerated, technology-enabled trend is Buy Now, Pay Later (BNPL). This is where shoppers divide their purchase into multiple (e.g., 4-6) equal payments and make the first payment at the time of checkout, typically online. Most (75%) BNPL users are Gen Z or millennials. Names of BNPL providers include AfterPay, Affirm, Klarna, and ZipPay. 

Unlike traditional layaway plans, which were very popular in the heyday of shopping malls, BNPL enables shoppers to get a product up front with the first payment instead of waiting, sometimes for months, until the final payment is made. However, if consumers miss a payment, there can be late fees and other penalties added to what they owe. 

Therefore, shoppers using BNPL should avoid buying things that they do not readily have money for. One study, however, found that nearly a third of BNPL users have struggled to keep up with payments.

Timeless Shopping Strategies

Clearly, Americans’ shopping experience has evolved over the past 100+ years. However, some timeless money-saving shopping practices remain. Look for deals (e.g., coupons in stores and discount codes online), compare at least three competing vendors for big purchases, and use credit cards wisely.

This post provides general personal finance or consumer decision-making information and does not address all the variables that apply to an individual’s unique situation. It does not endorse specific products or services and should not be construed as legal or financial advice. If professional assistance is required, the services of a competent professional should be sought.

 

 

Barbservations From Online RMD Webinars

After I left New Jersey and was no longer a recognizable figure as a financial educator for Rutgers University, I attended a few free meal seminars “undercover” in my new home state of Florida. Few people here know about my financial education work and I knew I wouldn't  be "outed" and asked to leave because I'm a CFP(R). 

Knowing that these seminars have been linked to an increased risk of abusive sales practices, if not outright investment fraud, and having read a detailed expose’ by Helaine Olen in the book Pound Foolish, I was curious to see the sales techniques used by the program organizers up close and personal.

Last year, I noticed a new trend that has continued into 2023: ads on social media about online financial seminars focused on required minimum distributions (RMDs) and income taxes owed in later life. In other words, no free meal; just the seminar…and the sales pitch. Curious as I was before, I attended 4 or 5 of these online seminars. Below are some of my “Barbservations”:

Canned Presentation- After viewing several webinars, I noticed that the event organizers were using the same slides and reading the same script, along with personal tweaks, of course. There must be a “central source” that provides program materials to event organizers. Unfortunately, some webinars that I viewed were not updated with latest (2022) IRS life expectancy factors.

 

Pesky Pop-Ups- Throughout all of the presentations, there were pop-up boxes on the screen encouraging viewers to sign up for a free consultation. This was very similar to postcards or door prize entry forms passed around at in-person seminars. In both situations, completing the forms was optional.

 

Scary Tactics- The webinars began with an image of a “tax train” about to run people over and the specter of the highest marginal tax bracket once again being 91% as it once was in the past (1951-1963). The colorful term “tax torpedo,” conjuring up a large explosion, was used to describe how a small income increment can result in a big increase in income taxes.

 

More Scary Tactics- A few that I noted were: “One or two bad years and your money is gone,” “massive amounts of government debt will cripple us,” “Uncle Sam is money hungry,” “taxes have no place to go but up,” and references to “Biden’s taxes,” to stir up some angry political undertones. Some presenters, no doubt prompted by a written script, also ripped up a sheet of paper several times to graphically illustrate the loss of $1million in savings due to taxes.

 

Teaser Tools- Some presenters offered free resources- but only to webinar viewers who made appointments for a consultation. These included an e-book, and something called “safe money tools.” One speaker also disparaged so-called “steak dinner guys” while acting just like them.

 

Kernels of Truth- Wrapped up in the colorful language and scare tactics was accurate core information: 1. Tax diversification throughout one’s working years can reduce taxes in later life, 2. Roth conversions and charitable gift planning (e.g., Qualified Charitable Distributions or QCDs) are strategies to reduce taxes, 3. RMD divisors grow by almost a factor of 1 every year, 4. Setting up automatic withdrawals with plan custodians can help avoid missed RMDs and tax penalties, and 5. Interest and/or dividends from investments should, ideally, satisfy RMDs, at least initially, with no impact on invested principal.

 

Bottom line: Be as cautious when attending online seminars as those that include free meals.

This post provides general personal finance or consumer decision-making information and does not address all the variables that apply to an individual’s unique situation. It does not endorse specific products or services and should not be construed as legal or financial advice. If professional assistance is required, the services of a competent professional should be sought.

What is Your Federal Income Tax Rate?

Knowing your tax rate can help you prepare a tax return and take action(s) to reduce your tax liability. Do you know your federal income tax rate? You may actually have several different tax rates (e.g., ordinary income, dividends, long-term capital gains), depending upon sources of taxable income. This post describes the different federal tax rates that apply to taxpayers.

Ordinary Income Tax Rate- The seven federal income tax brackets for ordinary income (e.g., salary/wages, interest income, short-term capital gains, and RMDs (withdrawals) from tax-deferred retirement plans) in 2022 and 2023 are 10%, 12%, 22%, 24%, 32%, 35%, and 37%.

 

These tax rates apply currently through 2025 under the Tax Cuts and Jobs Act. Income taxes are progressive (i.e., higher percentage of income for higher income earners) and taxpayers pay different tax rates on different tiers of income up to their last dollar earned.

 

Long-Term Capital Gains (LTCG) Rate- This is the tax rate assessed on profit from the sale of a capital asset (e.g., stock, bonds, mutual funds, property). To benefit from long-term capital gains rates, an asset must be held for more than a year (e.g., a year and a day or longer).

 

Current LTCG tax rates are 0%, 15%, and 20% and, like ordinary tax rates, they rise with income. The capital gain on the sale of an asset is calculated by subtracting its cost basis (initial deposit + subsequent deposits + commissions/fees to purchase the asset) from its sales price.

 

Capital Gains on Homes- There is special rule for capital gains from the sale of a primary residence that is owned and used for at least two of the last five years prior to its sale. Single tax filers can exclude up to $250,000 of capital gain and joint filers can exclude up to $500,000.

 

Qualified Dividend Tax Rate- This is the tax rate assessed on qualified dividends that are distributed by a taxpayer’s investments (e.g., stocks and mutual funds) in taxable (i.e., non-retirement) accounts. Like ordinary and LTCG tax rates, taxes on dividends are progressive.

 

The current tax rates assessed on qualified dividends (which are reported as such by account custodians) are 0%, 15%, and 20% depending on tax filing status (e.g., single, couple filing jointly, head of household,) and income. Ordinary dividends are taxed at ordinary tax rates.

 

Effective Tax Rate- While not an “official” tax rate that people use on their income tax returns, this is a very useful metric to analyze what percentage of your taxable income is being spent on federal income taxes. Many people also use their effective tax rate to estimate tax withholding. The formula for determining someone’s effective tax rate is Tax Liability divided by Taxable Income. 

Examples: $5,000 ÷ $45,000 = 11.1% and $40,000 ÷ $245,000 = 16.3%.

 

In summary, it is not enough to simply prepare your taxes to determine if you receive a refund or write a check to the IRS. Take the time to examine the tax rates that affect your income.

This post provides general personal finance or consumer decision-making information and does not address all the variables that apply to an individual’s unique situation. It does not endorse specific products or services and should not be construed as legal or financial advice. If professional assistance is required, the services of a competent professional should be sought.