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Tax Loss Harvesting

I’ve been known to use the expression, “Don’t let the tax tail wag the investing dog.” I stand by that remark. If you own a stock and it’s time to sell since it no longer is a stock your own criteria would justify, by all means, sell it. Holding it for an extra month to get long term favored gains may result in a greater loss than the missed long term treatment.

That said, the strategy of tax loss harvesting can help you boost your returns a bit depending on your timing. Let’s look at how this can work for you. First, you need to understand taxation of long term capital gains. There’s a zero percent rate for gains on sales of stocks (including mutual funds) held for over one year. But, there’s a catch. This great rate applies to those in the 10% or 15% brackets. If you take a peek at my last post, you’ll see that, in 2016, for a couple, the 15% bracket ends at $75,300. Add the exemptions and standard deduction, totaling $20,700, and this is an even $96,000, gross income. Less than 25% of households had more than this much income in 2014 according to the latest census data, so this strategy will help most of my readers. Last, understand the rules regarding wash sales. If you sell a stock or fund at a loss and purchase “substantially identical” funds or ETFs with 30 days, this triggers a wash sale. Earlier this year, Michael Kitces wrote an in depth article, Does Tax Loss Harvesting “Almost” Substantially Identical Mutual Funds And ETFs Trigger A Wash Sale Problem? For my purposes, selling an S&P tracking fund or ETF and buying a larger index, whether tracking the top 1000 or 1500 stocks should suffice.

You’re looking at your brokerage statement, and find you have 2 funds, one showing a $3000 gain, the other a $3000 loss. A contrived, simple example. For this discussion, we’ll assume they are generic, say S&P 500 index, and a broad Small Cap fund. If you sold both of these, and bought other funds this year, the loss and gain cancel, no tax due, no tax savings. Instead, sell the losing fund this year, buying into another fund reflecting your desired asset allocation. Now, you have a $3000 (the maximum you can take each year) loss, and you’ll see $450 more in your tax refund when you file. At the end of the following year, review your holdings, and if you won’t have a loser to sell in the next year, sell the one with the gain, and buy into another to keep your allocation to your goals. This move will raise your basis to the new, higher level, and should the market fall from this new level, you’ll have another chance to sell for a loss.

Let’s look at how this strategy could have been implemented over the decade from 2000 to 2009.

S&P2000

This is the ‘lost decade’ for the S&P, a remarkable 10 years that resulted in the S&P losing 9% of its value. You can click on the chart above to take a look, full size, or go to MoneyChimp and look at the returns for 2000 through 2009. In this crazy decade, we can take advantage of the market’s volatility by taking the losses along the way, and reinvesting this money. This example starts with a $30,000 investment account all reflecting the return of the S&P. For each year from 2000 though 2003 we are able to deduct a $3000 loss and get $450 back when filing. Note, even though 2003 had a gain, the S&P index dropped 40% in the 3 years from 2000 to 2002, and by shifting from one fund to another, there were $12,000 were of losses to claim over the 4 years. In the next few years, basis is increased by swapping funds. Here’s a chart illustrating this –

TaxLoss

You can see, the ‘regular’ return reflects the buy and hold, but ‘taking losses’ adds $450 each year we are able to take the $3000 loss. $3000 is the maximum you can take each year again ordinary income. Typically, losses first offset gains, but in our example, we’ll only take losses when they can be deducted against ordinary income. In this decade shown, losses are taken in each year from 2000 to 2003, and again in 2008 and 2009. The gains up to 2007 are used to increase basis by swapping funds, so in 2007, your basis is $36,697. Another fund swap in 2008, results in loss of over $13,000 letting you spread the deduction over the next 4+ years, so even though 2010 and 2011 showed gains, you are still taking a loss and adding $450 into the account.

The result of this annual effort is a 10% swing, instead of losing 9% for the decade, we are up just over 1%. To be fair, with expenses, we’d be just about at break-even, vs being down 9% plus expenses. Another way to look at it is that the return was improved by a full 1%/yr just from this strategy. No magic here, just using the rules of our tax code to write off losses against ordinary income, but take the gains tax free.

 

2016 Tax Rates Announced

The 2016 tax rates have just been announced by my friends at the IRS. My friends? Well, to be sure, they are not the enemy. The IRS enforces the tax code. You know who writes it? Congress. So whenever there’s a change in the code or something you don’t like, don’t look at the IRS, look toward Capitol Hill.

The tables aren’t the actual tax you pay on gross income, but on taxable income which is gross less a number of items, including the personal exemption which rises to $4,050 in ’16 and the standard deduction is unchanged at single $6,300 or joint $12,600.

I’ll be referring back to this article over the next year whenever the tax table is part of the conversation. Check out the new rate table and start planning for 2016.

2016-taxes

Money Management Involves Heeding the Message

A Guest Post from Crystal –

The level of debt amongst ordinary American citizens suggests that few are really good at managing money. While no one is suggesting it is always easy there are a few pointers that might be able to help you whatever your age. The tendency for people to spend what they earn each month and sometimes more makes saving and investment alien to a whole section of the population. You should resist that and start to pay more attention to your circumstances, present financial position and the future.

Investment

Some increase their assets relying on real estate. It has been a good way to build up money though the recession was a period when values dropped, sometimes alarmingly. In the medium to long term real estate however should always be a good investment. There are other alternatives. The S&P 500 has shown average growth since 1871 of over 10%. A single dollar invested in 1871 would now be worth $2.25 million, well ahead of inflation don’t you think? The figure is even better over the last 40 years. Even if you have no financial expertise you can expect good growth if you invest, the earlier in your adult life the better.
If you had started with only $500 in your first year and put aside $250 each year for investment over the next 30 years, that $8000 at 8% would have grown to over $35,000! The amounts involved are easily affordable are they not? Compound interest produces considerable growth over a long period.
It is a message that more young people seem to be getting rather than turning exclusively to student loans and the credit cards they can first obtain at the age of 18. The picture is still poor however with two thirds of students still needing to borrow at least 25% of their education costs knowing that it can take up to 10 years to pay off the loan. Figures show that this year’s graduates with student debt owe on average $35,000.

Household Debt

NerdWallet tells us that the average US household owes $15,000 or so with interest paid on credit cards reaching a massive $90 billion. Frightening, isn’t it? The picture doesn’t look good, yet compound interest results in money growing quickly. The smallest amount set aside will grow. The secret is to get rid of debt so that you can start to set it aside.
The terms of a student loan are not onerous but the interest that is added to any balance on a credit card every month could be described as penal. Some students who have used their first card for normal daily living will be paying a high price. It is one that many US households seem to be paying as well.

Employment Critical

As the US Economy improves after the years of recession unemployment figures are encouraging. Job are being created month on month and unemployment levels are back down to the level when the economy was buoyant before the recession hit. Those people that have a regular pay check coming in each month can look for an escape from expensive debt in today’s online lenders network at realisticloans.com that look at personal loan applicants and approve loans based upon the concept of affordability rather than credit score.
The application is quick and simple. All you have to do is to decide to act to sort out your financial problems. If you don’t the chances of building up a fund as illustrated above are minimal. Online lenders deal with applicants in this completely online process within hours of the email being sent. They require employment and bank details from applicants. If the sum being sought can be justified by the figures the money will be transferred electronically very quickly. A loan that can completely remove credit card debt is good news. The caveat is that you do not build up a balance again; there may not be an escape route.

Whatever your age you must think about the future and not rely on the Social Security System as your ultimate savior. The sooner you address any financial difficulties you have the better. Retirement years should be ones of comfort not sacrifice. They can be if you are proactive and don’t simply think the future will look after itself.

The Exaggerated Income Gap?

That was the title of a Barron’s article this past week. There’s been more and more press about the gap between the rich and the poor. In my work as a real estate agent focussing on renting to low income people, I see people who aren’t lazy, but just the opposite. Showing me proof of income made by working a 40+ hour week at a minimum wage job, and asking if we can take their cash income into account as well. The regular extra money they make doing some labor or babysitting nights or weekends. When you make $1400 a month working full time, you’re not going to able to afford much in the way of housing. We try to see three times a rent for income, i.e. $2400/mo income to qualify for an $800/mo apartment.

The Barron’s article started off with an observation, $1.4 trillion cash in the economy. The federal reserve backs up that number. The authors then make 2 logistical leaps that are beyond comprehension. First, that this cash is income. Forget for a moment that most people don’t keep more than a few hundred dollars sitting around. Even if they did, it only counted as income (declared or not) when it came in. The authors then assume that 80% of this money is income to the poorest 1/3 of households, the bottom 40 million families. Then, by magic, wait, not magic, a miracle. As in this cartoon.

miracle

Where was I? They conclude that the bottom 1/3 have an income that’s understated by as much as $30-$40K per year. To be fair to Barron’s and their real authors, the article was published in the “other voices” page.  This is where essays are solicited from readers who have some knowledge of finance. Whoever accepted this article blew it, in my opinion. Is there no cash economy? No. Of course there is. However, the numbers presented in the article offer bad math and a false conclusion. The income gap is so large that if it’s exaggerated by some percent, it’s still an issue. Sorry, Barron’s, this article isn’t worthy of your otherwise fine paper.

(Note: I am not condoning undeclared income, just putting it in perspective. A real estate agent is not an agent for the IRS, in fact we have an obligation to count any and all income, regardless of source.)

 

Christie’s Plan to Screw Your Retirement

It’s already election season, and we have 15 months to look forward to our politicians each jockeying for position, name calling, debating, all the way to the final two (or three?) we can choose from in November 2016. I am a personal finance blogger, and do my best to stay non-partisan, but when I hear proposals that will affect our tax code or cause me to change my advice on investing, I’m going to analyze it here.

Today, it’s Chris Christie’s proposal to cut social security benefits. First, he’d like to push the age for full retirement benefits from the current 67 to 69. For this part of his proposal, I’d like to address the elephant in the room. The fact that this impacts black men disproportionately from whites.

From the CDC, “In 2011, life expectancy at birth was 78.7 years for the total U.S. population, 76.3 years for males, and 81.1 years for females. Life expectancy was highest for Hispanics for both males and females. In each racial/ethnic group, females had higher life expectancies than males. Life expectancy ranged from 71.7 years for non-Hispanic black males to 83.7 years for Hispanic females.”

BlackWhiteLifeExp

In other words, on average, a 67 year old black man has 4.7 years left to live, and a white man, 9.3. This cuts the benefit by 42% for black men, but only 21% for whites. I read his proposal and didn’t have to search too long to find government number for life expectancy. Yet, in all the media I consume, all the articles on the Christie proposal, I have yet to see this addressed by anyone. (To my readers – This observation opens a discussion of a far larger issue, health care. In the long term, instead of tinkering with Social Security benefits, we need to close this gap.)

Next, we have his plan to reduce benefits for that he believes simply don’t need the money. How much is that? He would phase out the benefit for those with incomes from $80K to $200K. For a single person, that’s quite the range. In the last election, I recall $250K/yr being considered rich. And we discussed the difference between rich income vs rich wealth. It’s possible to make $250K and blow through every dime, and it’s also possible to make $100K and save your way to a $2M retirement fund. But here, we’re talking about retirement, and the connection between $80K and the wealth it represents is best thought of via the 4% rule. In other words, assuming I spent a lifetime of work saving to my 401(k) and IRA, pretax, it would take $2M of wealth to let me withdraw $80K per year. This takes an above average wage (or wages for a couple, but if one person passes early than the other, we still have a single person dealing with this money) but nowhere near what we consider “rich.”

At $80K taxable, we’ll ignore deductions for this discussion. This person might have as much as $40K in Social Security benefits. The furnace breaks, the roof needs replacing, a child needs help sending your granddaughter to college. Whatever the reason, $60K extra is withdraw from the 401(k). The tax rate this year would be 28%, netting $43,200 to pay a year’s tuition. But Christie would add an effective tax of $20K (i.e. confiscate half the SS benefit) and the net result is $23,200 from that $60,000 withdrawal. This results in a marginal rate of 61.3%.

What I find most troubling is the Catch-22 in which we all seem to find ourselves. Social Security feels like a retirement plan. From the time I started working, I’d get an annual statement, basically telling me that if I kept working to a certain age, 62,65,70, I’d expect a certain benefit. Yet, as many have noticed, the statement have a warning.

Your estimated benefits are based on current law. Congress has made changes to the law in the past and can do so at any time. The law governing benefit amounts may change because, by 2033, the payroll taxes collected will be enough to pay only about 77 percent of scheduled benefits.

This, and the warning that it’s really not a retirement plan, but an insurance, leaves us all encouraged to save all we can, 10-15% of our income being ideal. In my example above, it was more about how the retiree saved than how much. In hindsight, had the savings been post tax, subject to a 25% margin rate, the accumulation might be $1.5M instead of $2M. The tax on dividends would be 15%, as would cap gains. But withdrawals wouldn’t be considered income, and Christie’s horrific proposal could be moot. To be clear, his proposal doesn’t just hit the wealthy, but those who simply saved what they could in a responsible way.

More to come on the topics raised here. What do think about Christie’s proposal? If you agree with him, what am I missing? If not, how would it impact you? Last do you feel that Social Security is a “Entitlement” or do prefer to call it an “Earned Benefit”?

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