12 End of Year Tax Saving Tips

end of year tax saving tips

As we approach the close of 2019, we share our list of 12 end of year tax saving tips. Now is a great time to review your finances. You can make several smart and simple tax moves that can help lower your tax bill and increase your tax refund.

The Tax Cuts and Jobs Act of 2017 made sweeping changes in the tax code that affected many families and small business owners. If the previous tax season caught you off-guard, now you have a chance to redeem yourself.

Whether you file taxes yourself or hire a CPA, it is always better to be proactive. If you are expecting a large tax bill or your financials have changed substantially since last year, talk to your CPA. Start the conversation. Don’t wait until the last moment. Being ahead of the curve will help you make well-informed decisions without the stress of tax deadlines.

1. Know your tax bracket

The first step of mastering your taxes is knowing your tax bracket. 2019 is the second year after the TCJA took effect. One of the most significant changes in the tax code was introducing new tax brackets.

Here are the tax bracket and rates for 2019.

End of Year Tax Tips

2. Decide to itemize or use a standard deduction

Another big change in the tax law was the increase in the standard deduction. The standard deduction is a specific dollar amount that allows you to reduce your taxable income. As a result of this change, nearly 90% of all tax filers will take the standard deduction instead of itemizing. It makes the process a lot simpler for many Americans. Here are the values for 2019:

End of Year Tax Tips

3. Maximize your retirement contributions

Most contributions to qualified retirement plans are tax-deductible and will lower your tax bill.

  • For employees – 401k, 403b, 457 and TSP. The maximum contribution to qualified employee retirement plans for 2019 is $19,000. If you are at the age of 50 or older, you can contribute an additional $6,000.
  • For business owners – SEP IRA, Solo 401k and Defined Benefit Plan. Business owners can contribute to SEP IRA, Solo 401k, and Defined Benefits plans to maximize your retirement savings and lower your tax bill. The maximum contribution to SEP-IRA and Solo 401k in 2019 is $56,000 or $62,000 if you are 50 and older.

If you own SEP IRA, you can contribute up 25% of your business wages.

In a solo 401k plan, you can contribute as both an employee and an employer. The employee contribution is subject to a $19,000 limit plus a $6,000 catch-up. The employer match is limited to 25% of your compensation for the maximum $37,000. Depending on how you pay yourself, sometimes solo 401k can allow you for more savings than SEP IRA.

Defined Benefit Plans is an option for high-income earners who want to save more aggressively for retirement above the SEP-IRA and 401k limits. The DB plan uses actuary rules to calculate your annual contribution limits based on your age and compensation. All contributions to your defined benefit plan are tax-deductible, and the earnings grow tax-free.

4. Convert to Roth IRA

The process of transferring assets from a Traditional IRA or 401k plan to a Roth IRA is known as Roth Conversion. It allows you to switch from tax-deferred to tax-exempt retirement savings. You can learn more about the benefits of Roth IRA here.

The conversion amount is taxable for income purposes. The good news is that even though you will pay higher taxes in the current year, it may save you a lot more money in the long run.

While individual circumstances may vary, Roth Conversion could be very effective in a year with low or no income. Talk to your accountant or financial advisor. Ask if Roth conversion makes sense for you.

5. Contribute to a 529 plan

The 529 plan is a tax-advantaged state-sponsored investment plan, which allows parents to save for their children’s future college expenses. 529 plan works similarly to the Roth IRA. You make post-tax contributions. Your investment earnings grow free from federal and state income tax if you use them to pay for qualified educational expenses. Compared to a regular brokerage account, the 529 plan has a distinct tax advantage as you will never pay taxes on your dividends and capital gains.

Over 30 states offer a full or partial tax deduction or a credit on your 529 contributions. You can find the full list here. If you live in any of these states, your 529 contributions can lower your state tax bill significantly.

6. Make a donation

Donations to charities, churches, and various non-profit organizations are tax-deductible. You can support your favorite cause by giving back and lower your tax bill at the same time.

However, due to the changes in the new tax code, donations are tax-deductible only when you itemize your tax return. If you make small contributions throughout the year, you probably will be better off taking the standard deduction.

If itemizing your taxes is crucial for you, then you might want to consolidate your donations in one calendar year. So, instead of making multiple charitable contributions over the years, you can give one large donation every few years.

7. Sell losing investments

The process of selling losing investments to reduce your tax liability is known as tax-loss harvesting. It works for capital assets held outside retirement accounts (such as 401k, Traditional IRA, and Roth IRA). Capital assets may include real estate, cars, gold, stocks, bonds, and any investment property, not for personal use.

The IRS allows you to use capital losses to offset capital gains. If your capital losses are higher than your capital gains, you can deduct the difference as a loss on your tax return. This loss is limited to $3,000 per year or $1,500 if married and filing a separate return.

8. Prioritize long-term over short-term capital gains

Another way to lower your tax bill when selling assets is to prioritize long-term over short-term capital gains. The current tax code benefits investors who keep their assets for more than one calendar year. Long-term investors receive a preferential tax rate on their gains. While investors with short-term capital gains will pay taxes at their ordinary income tax level

Here are the long-term capital gain tax brackets for 2019:

End of Year Tax Tips

High-income earners will also pay an additional 3.8% net investment income tax.

9. Take advantage of FSA and HSA

With healthcare costs always on the rise, you can use a Flexible Spending Account (FSA) or a Health Savings Account (HSA) to cover your medical bills and lower your tax bill.

Flexible Spending Account (FSA)

A Flexible Spending Account (FSA) is a tax-advantaged savings account offered through your employer. The FSA allows you to save pre-tax dollars to cover medical and dental expenses for yourself and your dependents. The maximum contribution for 2019 is $2,700 per person. If you are married, your spouse can save another $2,700 for a total of $5,400 per family. Typically, you should use your FSA savings by the end of the calendar year. However, the IRS allows you to carry over up to $500 balance into the new year.

Dependent Care FSA (CSFSA)

A Dependent Care FSA (CSFSA) is a pre-tax benefit account that you can use to pay for eligible dependent care services, such as preschool, summer day camp, before or after school programs, and child or adult daycare. It’s an easy way to reduce your tax bill while taking care of your children and loved ones while you continue to work. The maximum contribution limit for 2019 for an individual who is married but filing separately is $2,500. For married couples filing jointly or single parents filing as head of household, the limit is $5,000.

Health Savings Account (HSA)

A Health Savings Account (HSA) is an investment account for individuals under a High Deductible Health Plan (HDHP) that allows you to save money on a pre-tax basis to pay for eligible medical expenses.The qualified High Deductible Plan typically covers only preventive services before the deductible. To qualify for the HSA, the HDHP should have a minimum deductible of $1,350 for an individual and $2,700 for a family. Additionally, your HDHP must have an out-of-pocket maximum of up to $6,750 for one-person coverage or $13,500 for family.

The maximum contributions in HSA for 2019, are $3,500 for self-only coverage and $7,000 for a family. HSA participants who are 55 or older can contribute an additional $1,000 as a catch-up contribution. Unlike the FSA, the HSA doesn’t have a spending limit, and you can carry over the savings in the next calendar year.

Keep in mind that the HSA has three distinct tax advantages. First, all HSA contributions are tax-deductible and will lower your tax bill. Second, you will not pay taxes on dividends, interest, and capital gains. Third, if you use the account for eligible expenses, you don’t pay taxes on those withdrawals either.

10. Defer income

Deferring income from this calendar year into the next year will allow you to delay some of the income taxes coming with it. Even though it’s not always possible to defer wages, you might be able to postpone a large bonus, royalty, or onetime payment. Remember, it only makes sense to defer income if you expect to be in a lower tax bracket next year.

Reversely, if you are expecting to be in a higher tax bracket tax year next year, you may consider taking as much income as possible in this tax year.

11. Buy Municipal Bonds

Municipal bonds are issued by local governments, school districts, and authorities to fund local projects that will benefit the general public. The interest income from most municipal bonds is tax-free. Investors in these bonds are exempt from federal income tax. If you buy municipal bonds issued in the same state where you live, you will be exempt from state taxes as well.

12. Take advantage of the 199A Deduction for Business Owners

If you are a business owner or have a side business, you might be able to use the 20% deduction on qualified business income. The TCJA established a new tax deduction for small business owners of pass-through entities like LLCs, Partnerships, S-Corps, and sole-proprietors. While the spirit of the law is to support small business owners, the rules of using this deduction are quite complicated and restrictive. For more information, you can check the IRS page. In summary, qualified business income must be related to conducting business or trade within the United States or Puerto Rico. The tax code also separates the business entities by industry – Qualified trades or businesses and Specified service trades or businesses.

Qualified versus specified service trade

Specified service businesses include the following trades: Health (e.g., physicians, nurses, dentists, and other similar healthcare professionals), Law, Accounting, Actuarial science, Performing arts, Consulting, Athletics, and Financial Services. Qualified trades or businesses is everything else.

For “specified service business,” the deduction gets phased out between $315,000 and $415,000 for joint filers. For single filers, the phase-out range is $157,500 to $207,500.

The qualified trades and businesses are also subject to the same phaseout limits. However, if their income is above the threshold, the 199A deduction becomes the lesser of the 20% of qualified business income deduction or the greater of either 50 percent of the W-2 wages of the business, or the sum of 25% of the W-2 wages of the business and 2.5% of the unadjusted basis immediately after acquisition of all qualified property.

If this all sounds very complicated to you, it’s because it is complicated.Contact your accountant or tax adviser to see if you can take advantage of this deduction.

Solving the student debt crisis

Student Debt Growth

The looming student debt crisis

As a financial advisor working with many young families, I am regularly discussing college planning. Many of my clients want to help their children with the constantly growing college tuition. Currently, the amount of US student debt is $1.56 trillion spread among 45 million borrowers. By 2023, 40% of borrowers can default on their loans. I am not running for a president, but I am very curious about the upcoming debate about fighting the upcoming student debt in America.

One recent proposal from the Republican party was to allow 529 plan participants to pay off student debt.

Another proposal from the presidential candidate Elizabeth Warren is to cancel student debt partially or entirely for households based on their income. Furthermore, many Democrat Candidate signed for free public college for all.

While all these ideas have certain merits, I am not confident that they will solve the problem long-term. As a parent and married to my wife who is paying off student loans, I would like to share my opinion.  Here are some of my suggestions

Promote 529 plans

In one of my previous articles, I discussed the benefits of 529 plans. Sadly, only 30% of US families know about or use 529 plans. It’s really striking how little Americans know about this option. 529 plans are state-sponsored tax-advantaged investment accounts allowing parents and other family members to save for qualified college expenses. It literally takes 5-10 minutes to open a 529 account.

Make 529 contributions tax-deductible

Currently, 529 contributions are after taxes. The tax advantage comes from not paying taxes on any future capital gains if you use the funds to pay for eligible college expenses. Additionally, over 30 states offer full or partial state income tax deduction on 529 contributions.

I would like to go one step further and propose federal income tax deduction up to a certain annual limit (say $5,000 or $10,000) with a phaseout over certain household income level (call it $250,000). This income deduction will help low and middle-class families save for college without putting a massive strain on their budget.  

Expand the Employer-sponsored 529 plans

In reality, most US families do not use the 529 plan because they don’t know about them or are uncertain about their investment choices. One way to popularize the 529 plan is motivating employers to include them as part of their benefits package similar to 401k plans. Employees can set up automatic payroll deposits and make regular contributions to their 529 accounts. Unfortunately, according to a recent survey by Gradadvisor, only 7% of employers offer 529 plans through their benefits.

Currently, the employer 529 match is taxable income to the parent. At the end of the year, the parent must pay personal taxes on any amount received through their employer.

I believe this provision is discouraging a lot of people to participate in these plans. In order to encourage higher participation in employer-sponsored 529 plans., the employer match should not be treated as income to the parent if used for qualified educational expenses.

Promote more work-study grants and employer-sponsored scholarships

Many college graduates leave school unprepared for the real world. Sometimes, I feel that there is a disconnect between skills learned at school and those needed to compete in the work marketplace.

While many public and private schools are doing a great job in teaching students those skills, I think we can do much better by connecting the school programs with the business. Let’s face it. Unless you are from an Ivy League school, how many students have had the chance to speak to a corporate CEO, a successful small business owner or a community leader.

With US unemployment at a record low, many businesses are struggling to find qualified workers. If we can encourage schools and employers to work together and set up employer-sponsored scholarships, internship programs, and work-study grants, we will have a lot more students learning real-life skills, earn money while study and potentially come out with smaller or no student loans.

Have personal finance as a mandatory class in high school and college

Only 1/3 states require a mandatory personal finance class in high school. And zero states mandate it in college. It may sound radical, but I believe that every high school and public college should require one personal finance class in the curriculum regardless of the student major.

Teaching kids and young adults essential financial skills like saving money, budgeting, and investing will help them make better choices later in life.

It also means that we need to find teachers who can coach personal finance. Unfortunately, finance and economics are mostly taught in business schools and largely ignored outside of the space. This is where connecting schools with local business leaders can be helpful.

Extend the Non-Taxable Loan Forgiveness

There are several Federal and State programs that offer Loan Forgiveness. However, in most cases, student loan forgiveness is treated as taxable income in the year when the loan was written off.  For some borrowers performing public service or working as teachers, lawyers and physicians in underserved areas, the loan forgiveness can be tax-free.

If your employer offers to pay off your student loans, you will receive a tax bill from the IRS. The amount of your forgiven loan will be added to your annual income and taxed as ordinary income. Knowing this tax trap, very few people opt for that option. If you can’t afford to pay off your student loan, what are the chances you can pay the taxes on the loan forgiveness?

Separately, being an elementary school teacher in a desirable area like Manhattan or San Francisco doesn’t make you financially better off than the rest of your colleagues. Most teachers can’t afford to live in San Francisco or Manhattan on a teacher’s salary, how do we expect them to pay off their loans.

Furthermore, non-taxable loan forgiveness should be designed to reward responsible borrowers who are paying off their loans regularly. I think a dollar to dollar match could encourage more people to pay off their loans.

What about loan cancellation

Canceling loans entirely or partially is a very admirable idea but it could turn into a double-edged sword. On one hand, it’s not completely fair to people who are diligently paying off their student loans month after month. And on the other hand, loan cancellation will encourage more people to take on student debt and not pay it. It might provide temporary relief, but it will not solve the problem long-term. I much rather find a way to empower and educate borrowers.

Improve student access to financial advice

How many parents or students speak to a financial advisor before taking a student loan? I bet a lot less than we hope for. Maybe it’s partially our fault as finance professionals but as a society, we need to find a way to get more financial advisors and colleges.

Before the TJCA of 2017, professional service expenses such as fees for CPAs and financial advisors were tax-deductible. I am not sure how many people took advantage of this deduction, probably not too many, but it was one way to encourage people to seek professional financial advice.

The sad truth is that the people who can afford financial advice are not those who needed it the most. So how about, make the financial advisory fees tax-deductible for low income and middle-class families. Or encourage financial advisors to provide free public service. I believe many of my colleagues will be happy to provide free advice in a meaningful and impactful way.

Reach out

If you’d like to discuss how to pay off your student loans, open a new 529 plan or make the most out of your existing 529 account, please feel free to reach out and learn more about my fee-only financial advisory services. I can meet you in one of our offices in San Francisco, Oakland, Walnut Creek, and Pleasant Hill areas or connect by phone. As a CFA® Charterholder with an MBA degree in Finance and 15+ years in the financial industry, I am ready to answer your questions.

Stoyan Panayotov, CFA 
Founder | Babylon Wealth Management

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Saving for college with a 529 plan

College savings with a 529 plan

What is a 529 plan?

The 529 plan is a tax-advantaged state-sponsored investment plan, which allows parents to save for their children college expenses.

In the past 20 years, college expenses have skyrocketed exponentially putting many families in a difficult situation.  Between 1998 and 2018, college tuition and fee have doubled in most private non-profit schools and more than tripled in most 4-year public colleges and universities.

College tuition and fees growth between 1998 and 2018.
Source: College Board

With this article, I would like to share how the 529 plan can help you send your kids or grandkids to college.

Student Debt is Growing

The student debt has reached $1.56 trillion with a growing number of parents taking on student loans to pay for their children’ college expenses. The total number of US borrowers with student loan debt is now 44.7 million.

Amid this grim statistic, less than 30% of families are aware of the 529 plan. The 529 plan could be a powerful vehicle to save for college expenses. Fortunately, 529 plans have grown in popularity in the past 10 years. There are more than 13 million 529 accounts with an average size of $24,057.

Let’s break down some of the benefits of the 529 plan.

College Savings Made Easy

Nowadays, you can easily open an account with any 529 state plan in just a few minutes and manage it online. You can set up automatic contributions from your bank account. Also, many employers allow direct payroll deductions and some even offer a match. Your contributions and dividends are reinvested automatically., so you don’t have to worry about it yourself. As a parent, you can open a 529 plan with as little as $25 and contribute as low as $15 per pay period. Most direct plans have no application, sales, or maintenance fees. 529 plan is affordable even for those on a modest budget.

529 plan offers flexible Investment Options

Most 529 plans provide a wide variety of professionally managed investment portfolios including age-based, indexed, and actively-managed options. The age-based option is an all-in-one portfolio series intended for those saving for college. The allocation automatically shifts from aggressive to conservative investments as your child approaches college age.

Alternatively, you can design your portfolio choosing between a mix of actively managed and index funds, matching your risk tolerance, timeline, and investment preferences. Some 529 plans offer guaranteed options, which limit your investment risk but also cap your upside.

Earnings Grow Tax-Free

529 plan works similarly to the Roth IRA. You make post-tax contributions. And your investment earnings will grow free from federal and state income tax when used for qualified expenses. Compared to a regular brokerage account, the 529 plan has a distinct tax advantage as you will never pay taxes on your dividends and capital gains.

Tax-exempt growth
529 plan versus taxable investment account
The chart hypothetically assumes a $6,300 annual contribution, a 5% average annual return and a 20% average tax rate on taxable income in a comparable brokerage account. The final year post-tax difference would be $14,539, without taking into consideration state tax deductions.on contributions and impact on financial aid application.

Your State May Offer a Tax Break

Over 30 states offer a full or partial tax deduction or credit on your 529 contributions. You can find the full list here. If you live in any of these states, your 529 contributions can lower significantly your state tax bill. However, these states usually require you to use the state-run 529 plan.

If you live in any of the remaining states that don’t offer any state tax deductions, such as California, you can open a 529 account in any state of your choice.

Use at Schools Anywhere

529 funds can be used at any accredited university, college or vocational school nationwide and more than 400 schools abroad. Basically, any institution eligible to participate in a federal student aid program qualifies. A 529 plan can be used to pay for tuition, certain room and board costs, computers and related technology expenses as well as fees, books, supplies, and other equipment.

The TCJA law of 2017 expanded the use of 529 funds and allowed parents to use up to $10,000 annually per student for tuition expenses at a public, private or religious elementary, middle, or high school. However, please check with your 529 plan as not all states passed that provision

Smaller Impact on Scholarship and Financial Aid

Many parents worry that 529 savings can adversely affect eligibility for scholarships and financial aid. Fortunately, 529 plan savings have no impact on merit scholarships. You can even withdraw funds from the 529 plan penalty-free up to the amount of the student scholarship.

For FAFSA, funds are typically treated as ownership of the parent, not the child, reducing the impact on financial aid application. A key component of the financial aid application is the Expected Family Contribution (EFC). Since 529 plans are considered parents’ assets, they are assessed at 5.64% of their value. For comparison, any accounts owned directly by the student such as custodial accounts (UTMAs, UGMAs), trusts and investment accounts are assessed at 20% of their value.

Lower Cost versus Borrowing Money

Starting the 529 plan early can save you money in the long run. The tax advantages of the 529 plan combined with the compounding growth over 18 years it will provide you with substantial long-term savings compared to taking a student loan.

529 plan provide Estate Tax Planning Benefits

Your 529 plan contributions may qualify for an annual gift tax exclusion of $15,000 per year for single filers and $30,000 a year for couples. The 529 plan is the only investment vehicle that allows you to contribute up to 5 years’ worth of gifts at once — for a maximum of $75,000 for a single filer and $150,000 for couples.

Other Family Members Can Contribute Too

Grandparents, as well as other family and friends, can make gifts to your 529 account. They can also set up their own 529 accounts and designate your child as a beneficiary. The grandparent-owned 529 account is not reportable on the student’s FAFSA, which is good for financial aid eligibility. However, any distributions to the student or the student’s school from a grandparent-owned 529 will be added to the student income on the following year’s FAFSA. Student income is assessed at 50%, which means if a grandparent pays $10,000 of college costs it would reduce the student’s eligibility for aid by $5,000.

Transfer funds to ABLE Account

Achieving a Better Life Experience (ABLE) account was first introduced in 2014. The ABLE account works similarly to a 529 plan with certain conditions. It allows parents of children with disabilities to save for qualified education, job training, healthcare, and living expenses.

Under the TCJA law, 529 funds can be rolled over into an ABLE account, without paying taxes or penalties.

Assign Extra Funds to Other Family Members

Finally, if your child or grandchild doesn’t need all the money or his or her education plans change, you can designate a new beneficiary penalty-free so long as they’re an eligible member of your family. Moreover, you can even use the extra funds for your personal education and learning new skills.

A financial checklist for young families

A financial checklist for young families

A financial checklist for young families…..Many of my clients are young families looking for help to build their wealth and improve their finances. We typically discuss a broad range of topics from buying a house, saving for retirement, savings for their kids’ college, budgeting and building legacy. As a financial advisor in the early 40s, I have personally gone through many of these questions and was happy to share my experience.

Some of my clients already had young children. Others are expecting a new family member. Being a dad of a nine-month-old boy, I could relate to many of their concerns. My experience helped me guide them through the web of financial and investment questions.  

While each family is unique, there are many common themes amongst all couples. While each topic of them deserves a separate post, I will try to summarize them for you.

Communicate

Successful couples always find a way to communicate effectively. I always advise my clients to discuss their financial priorities and concerns. When partners talk to each other, they often discover that they have entirely different objectives.  Having differences is normal as long as you have common goals. By building a strong partnership you will pursue your common goals while finding a common ground for your differences

Talking to each other will help you address any of the topics in this article.

If it helps, talk to an independent fiduciary financial advisor. We can help you get a more comprehensive and objective view of your finances. We often see blind spots that you haven’t recognized before.

Set your financial goals

Most life coaches will tell you that setting up specific goals is crucial in achieving success in life. It’s the same when it comes to your finances. Set specific short-term and long-term financial goals and stick to them. These milestones will guide you and help you make better financial decisions in the future.

Budget

There is nothing more important to any family wellbeing than budgeting. Many apps can help you budget your income and spending. You can also use an excel spreadsheet or an old fashion piece of paper. You can break down your expenses in various categories and groups similar to what I have below. Balance your budget and live within your means.

Sample budget

Gross Income?????
Taxes???
401k Contributions??
Net Income????
Fixed Expenses
Mortgage?
Property Taxes?
Utilities (Phone, Cable, Gas, Electric)?
Insurance?
Healthcare/Medical?
Car payment?
529 savings?
Daycare?
Non-Discretionary Flexible Expenses
Groceries?
Automotive (Fuel, Parking, Tolls)?
Home Improvement/Maintenance?
Personal Care?
Dues & Subscriptions?
Discretionary Expenses
Restaurants?
General Merchandise?
Travel?
Clothing/Shoes?
Gifts?
Entertainment?
Other Expenses?
Net Savings???

Consolidate your assets

One common issue I see amongst young couples is the dispersion of their assets. It’s very common for spouses to have multiple 401k, IRAs and savings accounts in various financial institutions and former employers. Consolidating your assets will help you get a more comprehensive view of your finances and manage them more efficiently.

Manage your debt

The US consumer debt has grown to record high levels. The relatively low-interest rates, rising real estate prices and the ever-growing college cost have pushed the total value of US household debt to $13.25 trillion. According to the New York Fed, here is how much Americans owe by age group.

  • Under 35: $67,400
  • 35–44: $133,100
  • 45–54: $134,600
  • 55–64: $108,300
  • 65–74: $66,000
  • 75 and up: $34,500

For many young families who are combining their finances, managing their debt becomes a key priority in achieving financial independence.

Manage your credit score

One way to lower your debt is having a high credit score. I always advise my clients to find out how much their credit score is.  The credit score, also known as the FICO score, is a measure between 300 and 850 points. Higher scores indicate lower credit risk and often help you get a lower interest rate on your mortgage or personal loan. Each of the three national credit bureaus, Equifax, Experian, and TransUnion, provides an individual FICO score.  All three companies have a proprietary database, methodology, and scoring system. You can sometimes see substantial differences in your credit score issued by those agencies.

Your FICO score is a sum of 64 different measurements. And each agency calculates it slightly differently. As a rule, your credit score depends mainly on the actual dollar amount of your debt, the debt to credit ratio and your payment history. Being late on or missing your credit card payments, maximizing your credit limits and applying for too many cards at once will hurt your credit score.

Own a house or rent

Owning your first home is a common theme among my clients. However, the price of real estate in the Bay area, where I live, has skyrocketed in the past 10 years. The average home price in San Francisco according to Zillow is $1.3 million. The average home price in Palo Alto is $3.1 million. (Source: https://www.zillow.com/san-francisco-ca/home-values/ ). While not at this magnitude, home prices have risen in all major metropolitan areas around the country. Buying a home has become an impossible dream for many young families. Not surprisingly a recent survey by the Bank of the West has revealed that 46% of millennials have chosen to rent over buying a home, while another 11% are staying with their parents.  

Buying a home in today’s market conditions is a big commitment and a highly personal decision. It depends on a range of factors including how long you are planning to live in the new home, available cash for a downpayment, job prospects, willingness to maintain your property, size of your family and so on.

Maximize your retirement contributions

Did you know that in 2019 you can contribute up to $19,000 in your 401k? If you are in your 50s or older, you can add another $6,000 as a catch-up contribution. Maximizing your retirement savings will help you grow your wealth and build a cushion of solid retirement savings. Not to mention the fact that 401k contributions are tax-deferred and lower your current tax bill.

Unfortunately, many Americans are not saving aggressively for retirement. According to Fidelity, the average person in their 30’s have $42.7k in their 401k plan. people in their 40s own on average 103k.

If your 401k balance is higher than your age group you are already better off than the average American.

Here is how much Americans own in their 401 plan by age group

  • 20 to 29 age: $11,500
  • 30 to 39 age: $42,700
  • 40 to 49 age: $103,500
  • 50 to 59 age: $174,200
  • 60 to 69 age: $192,800

For those serious about their retirement goals, Fidelity recommends having ten times your final salary in savings if you want to retire by age 67. They are also suggesting how to achieve this goal by age group.

  • By the age of 30: Have the equivalent of your starting salary saved
  • 35 years old: Have two times your salary saved
  • 40 years old: Have three times your salary saved
  • 45 years old: Have four times your salary saved
  • 50 years old: Have six times your salary saved
  • 55 years old: Have seven times your salary saved
  • 60 years old: Have eight times your salary saved
  • By age 67: Have 10 times your salary saved

Keep in mind that these are general guidelines. Everybody is different. Your family retirement goal is highly dependent on your individual circumstances, your lifestyle, spending habits, family size and alternative sources of income.

Know your risk tolerance level

One common issue I see with young families is the substantial gap between their risk tolerance and the actual risk they take in their retirement and investment accounts.  Risk tolerance is your emotional ability to accept risk as an investor.

I have seen clients who are conservative by nature but have a very aggressive portfolio. Or the opposite, there are aggressive investors with a large amount of cash or a large bond portfolio. Talking to a fiduciary financial advisor can help you understand your risk tolerance. You will be able to narrow that gap between your emotions and real-life needs and then connect them to your financial goals and milestones.

Diversify your investments

Diversification is the only free lunch you will get in investing. Diversifying your investments can reduce the overall risk of your portfolio. Without going into detail, owning a mix of uncorrelated assets will lower the long-term risk of your portfolio. I always recommend that you have a portion of your portfolio in US Large Cap Blue Chip Stocks and add some exposure to Small Cap, International, and Emerging Market Stocks, Bonds and Alternative Assets such as Gold and Real Estate.

Invest your idle cash

One common issue I have seen amongst some of my clients is holding a significant amount of cash in their investment and retirement accounts. The way I explain it is that most millennials are conservative investors. Many of them observed their parents’ negative experience during the financial crisis of 2008 and 2009. As a result, they became more risk-averse than their parents.  

However, keeping ample cash in your retirement account in your 30s will not boost your wealth in the long run. You are probably losing money as inflation is deteriorating the purchasing power of your idle cash. Even if you are a very conservative investor, there are ways to invest in your retirement portfolio without taking on too much risk.

Early retirement

I talk about early retirement a lot often than one might imagine. The media and online bloggers have boosted the image of retiring early and made it sound a lot easier than it is. I am not saying that early retirement is an illusion, but it requires a great deal of personal and financial sacrifice. Unless you are born rich or rely on a huge payout, most people who retire early are very frugal and highly resourceful. If your goal is to retire early, you need to pay off your debt now, cut down spending and save, save and save.

Build-in tax diversification

While most of the time we talk about our 401k plans, there are other investment and retirement vehicles out there such as Roth IRA, Traditional IRA and even your brokerage account. They all have their own tax advantages and disadvantages. Even if you save a million bucks in your 401k plan, not all of it is yours. You must pay a cut to the IRS and your state treasury. Not to mention the fact that you can only withdraw your savings penalty-free after reaching 59 ½. Roth IRA and brokerage account do not lower your taxes when you make contributions, but they offer a lot more flexibility, liquidity, and some significant future tax advantages. In the case of Roth IRA, all your withdrawals can be tax-free when you retire. Your brokerage account provides you with immediate liquidity and lower long-term capital gains tax on realized gains.

Plan for child’s expenses

Most parents will do anything for their children. But having kids is expensive. Whether a parent will stay at home and not earn a salary, or you decide to hire a nanny or pay for daycare, children will add an extra burden to your budget. Not to mention the extra money for clothes, food, entertainment (Disneyland) and even another seat on the plane.

Plan for college with a 529 Plan

Many parents want to help their children pay for college or at least cover some of the expenses. 529 plan is a convenient, relatively inexpensive and tax-advantageous way to save for qualified college expenses. Sadly, only 29% of US families are familiar with the plan. Most states have their own state-run 529 plan. Some states even allow state tax deductions for 529 contributions. Most 529 plans have various active, passive and age-based investment options. You can link your checking account to your 529 plan and set-up regular monthly contributions. There are plentiful resources about 529 plans in your state. I am happy to answer questions if you contact me directly.  

Protect your legacy

Many young families want to protect their children in case of sudden death or a medical emergency. However, many others don’t want to talk about it at all. I agree it’s not a pleasant conversation. Here in California, unless you have an established estate, in case of your death all your assets will go to probate and will have to be distributed by the court. The probate is a public, lengthy and expensive process. When my son was born my wife and I set up an estate, created our wills and assigned guardians, and trustees to our newly established trust.  

The process of protecting your legacy is called estate planning. Like everything else, it’s highly personalized depending on the size of your family, the variety of assets you own, your income sources, your charitable aptitude, and so on. Talking to an experienced estate attorney can help you find the best decision for yourself and your family.

I never sell insurance to my clients. However, if you are in a situation where you are the sole bread earner in the household, it makes a lot of sense to consider term life and disability insurance, which can cover your loved ones if something were to happen to you.

Plan ahead

I realize that this is a very general, kind of catch-all checkpoint but let me give it a try. No matter what happens in your life right now, I guarantee you a year or two from now things will be different. Life changes all the time – you get a new job, you have a baby, you need to buy a new car, or your company goes public, and your stock options make you a millionaire. Whatever that is, think ahead. Proper planning could save you a lot of money and frustration in the long run.

Conclusion

I realize that this checklist is not complete. Every family is unique. Each one of you has very different circumstances, financial priorities, and life goals. There is never a one-size-fits-all solution for any family out there. If you contact me directly, I will be happy to address your questions.

 

9 Smart Tax Saving Strategies for High Net Worth Individuals

9 Smart Tax Saving Strategies for High Net Worth Individuals

The Tax Cuts and Jobs Act (TCJA) voted by Congress in late 2017 introduced significant changes to the way high net worth individuals and families file and pay their taxes. The key changes included the doubling of the standard deduction to $12,000 for singles and $24,000 for married couples filing jointly, the elimination of personal exemptions, limiting the SALT deduction to $10,000, limiting the home mortgage interest deduction to loans of up to $750,000 versus $1,000,000 as well as comprehensive changes to itemized deductions and Alternative Minimum Tax.

Many high net worth individuals and families, especially from high tax states like California, New York, and New Jersey, will see substantial changes in their tax returns. The real impact won’t be completely revealed until the first tax filing in 2019. Many areas remain ambiguous and will require further clarification by the IRS.

Most strategies discussed in this article were popular even before the TCJA. However, their use will vary significantly from person to person.  I strongly encourage you to speak with your accountant, tax advisor, or investment advisor to better address your concerns.

1. Home mortgage deduction

While a mortgage tax deduction is rarely the primary reason to buy a home, many new home buyers will have to be mindful of the new tax rule limiting mortgage deductions to loans of up to $750,000. The interest on second home mortgages is no longer tax-deductible.  The interest on Home Equity Loans or HELOCs could be tax-deductible in some instances where proceeds are utilized to acquire or improve a property

2. Get Incorporated

If you own a business, you may qualify for a 20 percent deduction for qualified business income. This break is available to pass-through entities, including S-corporations and limited liability companies. In general, to qualify for the full deduction, your taxable income must be below $157,500 if you’re single or $315,000 if you’re married and file jointly. Beyond those thresholds, the TJLA sets limits on what professions can qualify for this deduction. Entrepreneurs with service businesses — including doctors, attorneys, and financial advisors — may not be able to take advantage of the deduction if their income is too high.

Furthermore, if you own a second home, you may want to convert it to a rental and run it as a side business. This could allow you to use certain tax deductions that are otherwise not available.

Running your business from home is another way to deduct certain expenses (internet, rent, phone, etc.). In our digital age, technology makes it easy to reach out to potential customers and run a successful business out of your home office.

3. Charitable donations

All contributions to religious, educational, or charitable organizations approved by the IRS are tax-deductible. The annual limit is 50% of your AGI (aggregate gross income) for most donations and 30% of AGI for appreciated assets.

While most often people choose to give money, you can also donate household items, clothes, cars, airline miles, investments, and real estate. The fair value of the donated items decreases your taxable income and therefore will reduce the amount of taxes due to IRS.

The TCJA made the tax planning for donations a little bit trickier. The new tax rules raised the standard deduction to $12,000 for singles and $24,000 for married couples filing jointly. In effect, the rule will reduce the number of people who are itemizing their taxes and make charitable donations a less attractive tax strategy.

For philanthropic high net worth individuals making charitable donations could require a little more planning to achieve the highest possible tax benefit. One viable strategy is to consolidate annual contributions into a single large payment. This strategy will ensure that your donations will go above the yearly standard deduction threshold.

Another approach is to donate appreciated investments, including stocks and real estate. This strategy allows philanthropic investors to avoid paying significant capital gain tax on low-cost basis investments. To learn more about the benefits of charitable donations, check out my prior post here.

4. Gifts

The TCJA doubled the gift and estate tax exemption to almost $11.18 million per person and $22.36 per married couple. Furthermore, you can give up to $15,000 to any number of people every year without any tax implications. Amounts over $15,000 are subject to the combined gift and estate tax exemption of $11 million.  You can give your child or any person within the annual limits without creating create any tax implications.

Making a gift will not reduce your current year taxes. However, making gifts of appreciated assets with a lower cost basis can be a way to manage your future tax payments and pass on the tax bill to family members who pay a lower tax rate.

5. 529 Plans

The TCJA of 2017 expanded the use of 529 plans to cover qualifying expenses for private, public, and religious kindergarten through 12th grade. Previously parents and grandparents could only use 529 funds for qualified college expenses.

The use of 529 plans is one of the best examples of how gifts can minimize your future tax burden. Parents and grandparents can contribute up to $15,000 annually per person, $30,000 per married couple into their child college education fund. The plan even allows a one–time lump-sum payment of $75,000 (5 years x $15,000).

Parents can choose to invest their contributions through a variety of investment vehicles.  While 529 contributions are not tax-deductible on a federal level, many states like New York, Massachusetts, Illinois, etc. allow for state tax deductions for up to a certain amount. The 529 investments grow tax-free. Withdrawals are also tax-free when used to pay cover qualified college and educational expenses. 

6. 401k Contributions

One of the most popular tax deductions is the tax-deferred contribution to 401k and 403b plans. In 2020 the allowed maximum contribution per person is $19,500 plus an additional $6,500 catch-up for investors at age 50 and older. Also, your employer can contribute up to $36,500 for a maximum annual contribution of $57,000 or $63,500 if you are older than 50.

The contributions to your retirement plan are tax-deductible. They decrease your taxable income if you use itemized deductions on your tax filing form. Not only that, but the investments in your 401k portfolio also grow tax-free. You will owe taxes upon withdrawal at your current tax rate at that time.

7. Roth IRA

Roth IRA is a great investment vehicle. Investors can contribute up to $6,000 per year. All contributions to the account are after-tax.  The investments in the Roth IRA can grow tax-free. And the withdrawals will be tax-exempt if held till retirement. IRS has limited the direct contributions to individuals making up to $124,000 per year with a phase-out at $139,000. Married couples can make contributions if their income is up to $196,000 per year with a phase-out at $206,000.

Fortunately, recent IRS rulings made it possible for high net worth individuals to make Roth Contributions.  Using the two-step process known as backdoor Roth you can take advantage of the long-term tax-exempt benefits of Roth IRA. Learn more about Roth IRA in our previous post here. 

8. Health Spending Account

A health savings account (HSA) is a tax-exempt saving account available to taxpayers who are enrolled in a high-deductible health plan (HDHP) The funds contributed to this account are tax-deductible. Unlike a flexible spending account (FSA), HSA funds roll over and accumulate year over year if not spent. HSA owners can use the funds to pay for qualified medical expenses at any time without tax liability or penalty. The annual contribution limits for 2018 are $3,450 per person, $6,900 per family, and an additional $1,000 if 55 or older. The owner of HSA can invest the funds similar to the IRA account.

In effect, HSAs have a triple tax benefit. All contributions are tax-deductible. Investments grow tax-free and. HSA owners can make tax-free withdrawals for qualified medical expenses.

9. Municipal bonds

Old fashioned municipal bonds continue to be an attractive investment choice of high net worth individuals. The interest income from municipal bonds is still tax-exempt on a federal level. When the bondholders reside in the same state as the bond issuer, they can be exempted from state income taxes as well.

Final words

If you have any questions about your existing investment portfolio, reach out to me at stoyan@babylonwealth.com or +925-448-9880.

You can also visit our Insights page where you can find helpful articles and resources on how to make better financial and investment decisions.