Know your tax brackets for 2024

Know Your Tax Bracket 2024

There are seven federal tax brackets for the 2024 tax year: 10%, 12%, 22%, 24%, 32%, 35%, and 37%. Every year, the IRS modifies the tax brackets for inflation. Your specific bracket depends on your taxable income and filing status. These are the rates for taxes due in April 2025.

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Marginal tax rate

The marginal tax rate is the highest tax rate you have to pay for every additional dollar of income you earn. A 25% marginal tax rate means you will pay 25 cents for every extra dollar you report on your earnings.

Effective Tax Rate

The effective tax rate is your total tax amount divided by your total earned income.

Single Filers Tax Brackets for 2024

10% $0 to $11,600 10% of taxable income
12% Over $11,600 but not over $47,150 $1,160 plus 12% of the excess over $11,600
22% Over $47,150 but not over $100,525 $5,426 plus 22% of the excess over $47,150
24% Over $100,525 but not over $191,950 $17,168.50 plus 24% of the excess over $100,525
32% Over $191,950 but not over $243,725 $39,110.50 plus 32% of the excess over $191,150
35% Over $243,725 but not over $609,350 $55,678.50 plus 35% of the excess over $243,725
37% Over $609,350 $183,647.25 plus 37% of the excess over $609,350

Married Filing Jointly Tax Brackets for 2024

10% $0 to $23,200 10% of taxable income
12% Over $23,200 but not over $94,300 $2,320 plus 12% of the excess over $23,200
22% Over $94,300 but not over $201,050 $10,852 plus 22% of the excess over $94,300
24% Over $201,050 but not over $383,900 $34,337 plus 24% of the excess over $201,050
32% Over $383,900 but not over $487,450 $78,221 plus 32% of the excess over $383,900
35% Over $487,450 but not over $731,200 $111,357 plus 35% of the excess over $487,450
37% Over $731,200 $196,669.50 plus 37% of the excess over $731,200

Married Filing Separately Tax Brackets for 2024

10% $0 to $11,600 10% of taxable income
12% Over $11,600 but not over $47,150 $1,160 plus 12% of the excess over $11,600
22% Over $47,150 but not over $100,525 $5,426 plus 22% of the excess over $47,150
24% Over $100,525 but not over $191,950 $17,168.50 plus 24% of the excess over $100,525
32% Over $191,950 but not over $243,725 $39,110.50 plus 32% of the excess over $191,150
35% Over $243,725 but not over $365,600 $55,678.50 plus 35% of the excess over $243,725
37% Over $365,600 $98,334.75 plus 37% of the excess over $365,600

Head of Household Tax Brackets for 2024

10% $0 to $16,550 10% of taxable income
12% Over $16,550 but not over $63,100 $1,655 plus 12% of the excess over $16,550
22% Over $63,100 but not over $100,500 $7,241 plus 22% of the excess over $63,100
24% Over $100,500 but not over $191,950 $15,469 plus 24% of the excess over $100,500
32% Over $191,950 but not over $243,700 $37,417 plus 32% of the excess over $191,150
35% Over $243,700 but not over $609,350 $53,977 plus 35% of the excess over $243,700
37% Over $609,350 $181,954.50 plus 37% of the excess over $609,350

2024 Standard Deduction

The amount of the standard deduction reduces your taxable income. Usually, the IRS adjusts the standard deduction for inflation every year.

You can choose a standard or itemized deduction when you file your taxes. It only makes sense to itemize your deductions if their total value exceeds the standard deduction.

2024 Standard Deduction
Filing Status Deduction Amount
Single $14,600
Married Filing Jointly $29,200
Head of Household $21,900

Long-term capital gain taxes

You owe a capital gains tax on the profit from selling capital assets such as stocks, options, bonds, real estate, and cryptocurrencies. Long-term capital gains have a more favorable tax treatment than ordinary taxable income. To qualify for long-term status, you must realize a profit on an investment after holding it for one calendar year or 365 days. Short-term capital gains are taxable as ordinary income.

Taxable Income Over
Tax Rate Single Married Filing Jointly Head of Household
0% $0 $0 $0
15% $47,025 $94,050 $63,000
20% $518,900 $583,750 $551,350

Net Investment Income tax

A net investment income tax of 3.8% applies to all taxpayers with net investment income above specific threshold amounts. In general, net investment income includes

  • Long Term Capital gains
  • Short capital gains
  • Dividends
  • Taxable interest
  • Rental and royalty income
  • Passive income from investments you don’t actively participate in
  • Business income from trading financial instruments or commodities
  • The taxable portion of nonqualified annuity payments

You will pay 3.8% of the smaller value between

  1. Your total net investment income, or
  2. the excess of modified adjusted gross income over the following threshold amounts:
  • $200,000 for single and head-of-household filers
  • $250,000 for married filing jointly or qualifying widow(er)
  • $125,000 for married filing separately

Alternative Minimum Tax Levels for 2024

The AMT exemption amount in 2024 is $85,700 for singles and $133,300 for married couples filing jointly.

In 2024, the 28% AMT rate applies to an excess AMT Income of $232,600 for all taxpayers ($116,300 for married couples filing separate returns).

AMT exemptions phase out at 25 cents per dollar earned once AMTI reaches $609,350 for single filers and $1,218,700 for married taxpayers filing jointly.

 

Tax Saving Moves for 2023

Tax Saving moves for 2023

Tax Saving Moves for 2023: As we approach the end of  2023, I am traditionally sharing my favorite list of tax-saving moves to help you lower your tax bill for 2023. The US tax rules change every year. 2023 was no exception.

2023 has been another challenging year for investors. The interest rates are rising, inflation is stabilizing but still high, and the stock market is volatile as always. Since we don’t have any control over the economy, proactive tax planning is essential for achieving your financial goals. Furthermore, comprehensive financial and tax planning is critical to attaining tax alpha. Making smart tax decisions can help you grow your wealth while you prepare for various outcomes. 

Today, you have an excellent opportunity to review your finances. You can make several smart and easy tax moves to lower your tax bill and increase your tax refund. Being ahead of the curve will help you make well-informed decisions without the stress of tax deadlines. Start the conversation today. 

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1. Know your tax bracket

The first step in managing your taxes is knowing your tax bracket. 2023 federal tax rates fall into the following brackets depending on your taxable income and filing status. Knowing where you land on the tax scale can help you make informed decisions, especially when you plan to earn additional income, exercise stock options, or receive RSUs

Here are the Federal tax bracket and rates for 2023.

Tax Rate Single Filers Married Individuals Filing Joint Returns Heads of Households Married Individuals Filing Separately
10% $0 to $11,000 $0 to $22,000 $0 to $15,700 $0 to $11,000
12% $11,000 to $44,725 $22,000 to $89,450 $15,700 to $59,850 $11,000 to $44,725
22% $44,725 to $95,375 $89,450 to $190,750 $59,850 to $95,350 $44,725 to $95,375
24% $95,375 to $182,100 $190,750 to $364,200 $95,350 to $182,100 $95,375 to $182,100
32% $182,100 to $231,250 $364,200 to $462,500 $182,100 to $231,250 $182,100 to $231,250
35% $231,250 to $578,125 $462,500 to $693,750 $231,250 to $578,100 $231,250 to $323,925
37% $578,125 or more $693,750 or more $578,100 or more $323,925 or more

2. Decide to itemize or use a standard deduction

The standard deduction is a specific dollar amount that allows you to reduce your taxable income. Nearly 90% of all tax filers use the standard deduction instead of itemizing. It makes the process a lot simpler for many Americans. However, in some circumstances, your itemized deductions may surpass the dollar amount of the standard deduction and allow you to lower your tax bill even further.

Here are the values for 2023:

Filing Status Deduction Amount
Single $13,850
Married Filing Jointly $27,700
Head of Household $20,800

3. Maximize your retirement contributions

You can save taxes by contributing to a retirement plan. Most contributions to qualified retirement plans are tax-deductible and lower your tax bill.

  • For employees – 401k, 403b, 457, and TSP. The maximum contribution to qualified employee retirement plans for 2023 is $22,500. If you are  50 or older, you can contribute an additional $7,500.
  • For business owners – SEP IRA, Solo 401k, and Defined Benefit Plan. Business owners can contribute to SEP IRA, Solo 401k, and Defined Benefit Plans to maximize their retirement savings and lower their tax bills. The maximum contribution to SEP-IRA and Solo 401k in 2023 is $66,000 or $73,500 if you are 50 and older.

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

In a solo 401k plan, you can contribute as an employee and an employer. The employee contribution is subject to a $22,500 limit plus a $7,500 catch-up. The employer match is limited to 25% of your compensation for a maximum of $43,500. In many cases, the solo 401k plan can allow you to save more than a SEP IRA.

A defined Benefit Plan 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. Roth conversion

Transferring investments 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. 

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

If you believe your taxes will go up in the future, Roth Conversion could be a very effective way to manage your future taxes. 

5. Contribute to a 529 plan

The 529 plan is a tax-advantaged state-sponsored investment plan allowing 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. The 529 plan has a distinct tax advantage compared to a regular brokerage account, 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 complete list here. Your 529 contributions can significantly lower your state tax bill if you live in these states.

6. Make a donation

Donations to charities, churches, and various non-profit organizations are tax-deductible. You can support your favorite cause by simultaneously giving back and lowering your tax bill. Your contributions can be in cash, household goods appreciated assets, or directly from your IRA distributions. 

Charitable donations are tax-deductible only when you itemize your tax return. If you make small contributions throughout the year, you might be better off taking the standard deduction.

If itemizing your taxes is crucial, 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. Tax-loss harvesting

The stock market is volatile. If you are holding stocks and other investments that dropped significantly in 2023, you can consider selling them. Selling losing investments to reduce your tax liability is known as tax-loss harvesting. It works for capital assets outside retirement accounts (401k, Traditional IRA, and Roth IRA). Capital assets may include real estate, cryptocurrency, cars, gold, stocks, bonds, and any investment property not for personal use.

The IRS allows you to use capital losses to offset capital gains. You can deduct the difference as a loss on your tax return if your capital losses exceed your capital gains. This loss is limited to $3,000 annually or $1,500 if married and filing a separate return. Furthermore, you can carry forward your capital losses for future years and offset future gains.

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 2023:

LTCG Tax Brackets 2023 IRS

Furthermore, high-income earners will also pay an additional 3.8% net investment income tax.

9. Contribute to FSA

With healthcare costs constantly increasing, you can use a Flexible Spending Account (FSA)  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 pretax dollars to cover medical and dental expenses for yourself and your dependents. 

The maximum contribution for 2023 is $3,050 per person. If you are married, your spouse can save another $3,050 for $6,100 per family. Some employers offer a matching FSA contribution for up to $500. Typically,  you must use your FSA savings by the end of the calendar year. However, for 2023, the maximum carryover amount is $610, which you can roll over for the following calendar year.

Dependent Care FSA (DC-FSA)

A Dependent Care FSA  is a pretax 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. You can reduce your tax bill while taking care of your children and loved ones while you continue working.

The American Rescue Plan Act (ARPA) raised pretax contribution limits for dependent care flexible spending accounts (DC-FSAs) for 2023.   For married couples filing jointly or single parents filing as head of household, the maximum contribution limit is $5,000. 

10. Buy an electric vehicle

if you purchase an electric car with a final assembly in North America, you might be eligible for a Federal tax credit. Many states have separate incentives. The maximum credit is $7,500, depending on your income, the size of the vehicle, and its battery capacity.

The credit equals:

  • $2,917 for a vehicle with a battery capacity of at least 5 kilowatt hours (kWh)
  • Plus $417 for each kWh of capacity over 5 kWh

Check the IRS website for the most recent list of vehicles and rules.

11. Contribute to a 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 pretax basis to pay for eligible medical expenses.

Keep in mind that the HSA has three distinct tax advantages.

  1. All HSA contributions are tax-deductible and will lower your tax bill.
  2. Your investments grow tax-free. You will not pay taxes on dividends, interest, and capital gains.
  3. You don’t pay taxes on those withdrawals if you use the account 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 $1,500 for an individual and $3,000 for a family. Additionally, your HDHP must have an out-of-pocket maximum of up to $7,500 for one-person coverage or $15,000 for families.

The maximum contributions in HSA for 2023 are $3,850 for individual coverage and $7,750 for families. HSA participants of age 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.

12. Defer or accelerate income

Is 2023 shaping up to be a high income for you? Perhaps you can defer some of your income from this calendar year into 2024. This move will allow you to reduce or delay higher income taxes. Even though it’s not always possible to defer wages, you might be able to postpone a large bonus, royalty, capital gains, option exercise, or one-time payment. Remember, it only makes sense to defer income if you expect to be in a lower tax bracket next year.

On the other hand, if you expect to be in a higher tax bracket next year, you may consider taking as much income as possible in 2023.

Smart Strategies for Reducing Taxes on Required Minimum Distributions

Reduce taxes on Required Minimum Distributions

What is RMD?

Required Minimum Distributions (RMDs) are mandatory withdrawals that individuals with tax-advantaged retirement accounts like Traditional IRAs, SEP IRAs, and 401k must take after reaching a certain age. These accounts come with certain tax advantages. Typical contributions are tax-deductible. And all earnings grow tax-free.

The purpose of RMDs is to ensure that individuals eventually withdraw their retirement savings in these accounts and pay the appropriate taxes on those withdrawals.

Key points about Required Minimum Distributions:

Age Requirement: You are generally required to start taking RMDs from your retirement accounts by April 1 of the year following the year you turn 73. However, if you turned 70½ before January 1, 2020, the previous age for RMDs was 70½.

The SECURE Act of 2019 increased the RMD age from 70½ to 72 years. Eventually, the SECURE 2.0 Act of 2022 delayed the RMD age—from 72 to 73—starting in 2023. Furthermore, in 2033, the RMD age will increase to age 75.

Calculating RMDs: The IRS provides a formula to calculate your RMD for each account. Your RMD  will be based on your age, account balance, and life expectancy. The formula uses the account balance as of December 31 of the previous year.

Types of Accounts: RMD rules apply to Traditional IRAs, SEP IRAs, SIMPLE IRAs, 401(k) plans, 403(b) plans, and other tax-advantaged retirement accounts. Roth IRAs are not subject to RMDs during the original account holder’s lifetime.

Taxation: RMDs are generally taxable as ordinary income and are subject to income tax at your applicable tax rate for the year you take them.

Penalties for Not Taking RMDs: Failing to take the required distribution can result in substantial fines. The IRS imposes a penalty of 25% of the RMD amount not withdrawn. SECURE 2.0 Act dropped the excise tax rate 10% if you timely correct your RMDs within two years.

Withdrawal Flexibility: You can always withdraw more than the RMD amount. However, excess withdrawals do not count toward future RMDs.

Inherited Retirement Accounts: If you inherit a retirement account, RMD rules can vary depending on your relationship with the original account holder and the age of the deceased account holder at the time of their passing.

RMD Withdrawal strategies

As individuals approach retirement, they often face a new financial challenge – high taxes on Required Minimum Distributions (RMDs). These mandatory withdrawals from retirement accounts can lead to significant tax liabilities. However, there are several strategic approaches to minimize the tax burden from RMDs, ranging from early Roth contributions to charitable giving. Let’s explore some of these strategies and emphasize the importance of taking a comprehensive view of your retirement plan.

Early Roth Contributions

One of the most effective ways to reduce RMD taxes is by making early contributions to a Roth IRA and Roth 401. Unlike Traditional IRAs and 401(k)s, Roth IRAs allow for tax-free withdrawals in retirement. By contributing to a Roth IRA when you’re younger, you’re building a tax-free source of income for retirement. Moreover, Roth IRAs have no minimum distribution requirements during your lifetime, so you can let your investments grow tax-free for as long as you wish.

Roth Conversions

Considering a Roth conversion might be beneficial if you already have a substantial balance in your Traditional IRA or 401(k). Roth conversion involves transferring a portion of your pre-tax retirement savings into a Roth IRA. While you will pay taxes on the conversion amount, it can be a strategic move to lower future RMDs and ultimately reduce your overall tax burden in retirement. You can plan to make these conversions gradually over several years to lessen their tax impact.

Qualified Charitable Donations

Qualified Charitable Donations (QCDs) offer an excellent way to satisfy your RMD requirement while reducing your taxable income. You can directly transfer up to $100,000 per year from your IRA or 401k to a qualified charity without counting it as income. The QCD not only reduces your tax liability but also supports a cause you care about. QCDs are especially advantageous if you don’t need your entire RMD for living expenses.

Charitable Gift Annuity

A Charitable Gift Annuity (CGA) is another charitable giving option that can help lower your RMD tax burden. With a CGA, you donate a lump sum to a charity in exchange for regular fixed payments for life. These payments are typically partially tax-free, reducing your taxable income and potentially placing you in a lower tax bracket. The size of your payment depends on many factors, including your age when you set up the charitable gift annuity. Younger donors typically receive smaller amounts but for an extended period.

Take Distributions Early

Taking distributions early can be a strategic move for those who have control over their retirement accounts and aren’t relying solely on RMDs for income. By withdrawing money from your retirement accounts before age 73, you can manage your tax liability more effectively. This strategy lets you control when and how much you withdraw, potentially spreading the tax burden over several years.

Take a Comprehensive View

The key to effectively reducing the tax burden of your RMDs is to take a comprehensive view of your financial situation.

Taking a comprehensive view of your overall financial plan is paramount to ensuring a secure and comfortable retirement. It involves not only meeting the IRS requirements but also aligning these distributions with your broader financial goals and circumstances. By considering your entire financial portfolio, including other sources of income, investment strategies, tax implications, and long-term retirement objectives, you can optimize your RMD strategy. This holistic approach helps you strike a balance between satisfying regulatory requirements and making the most of your retirement savings. It also allows for modifications as your financial situation evolves over time, ensuring that your retirement plan remains flexible, robust, and tailored to your unique needs. In essence, taking a comprehensive view empowers you to navigate the intricacies of RMDs within the context of your broader financial well-being, ultimately enhancing your financial security during retirement.

Conclusion

RMDs are an inevitable part of retirement income. With the right strategies, you can significantly reduce the associated tax burden. From early Roth contributions and conversions to charitable giving options like QCDs and CGAs, there are numerous ways to optimize your retirement plan. It’s crucial to take a comprehensive view, considering all available strategies and their impact on your overall financial picture. By doing so, you can enjoy a more financially secure and tax-efficient retirement.

Consider working with a financial advisor or tax professional to create a retirement income strategy encompassing all available options. This strategy should align with your long-term financial goals, risk tolerance, and charitable intentions.

Planning for Retirement with Stock Options and RSUs: A Comprehensive Guide

Planning for Retirement with Stock Options and RSUs

Planning for Retirement with Stock Options and RSUs can be complex and overwhelming. Retirement planning is a crucial aspect of your financial independence. And for individuals fortunate enough to have stock options and Restricted Stock Units (RSUs) as part of their compensation package, these assets can play a significant role in securing a comfortable retirement. This article will delve into stock options and RSUs, discussing Incentive Stock Options (ISOs), Non-Qualified Stock Options (NQSOs), RSUs, and Restricted Stock. We’ll explore how these assets can be integrated into your retirement plan while considering various tax implications, concentrated risk, and the importance of a comprehensive financial view.

Understanding Stock Options and RSUs

Incentive Stock Options (ISOs)

Incentive Stock Options, or ISOs, are a type of stock option usually granted to employees as an incentive. They come with tax advantages but also have specific requirements. ISOs allow employees to purchase company stock at a predetermined price, known as the exercise or strike price. To qualify for favorable tax treatment, ISOs must be held for at least two years from the date of grant and one year from the date of exercise. Gains from ISOs are typically taxed at the more favorable long-term capital gains rate.

  • Favorable tax treatment
  • Long-term capital gain tax is 15% or 20% versus your tax bracket
  • Maximum $100,000 of underlying stock value per year
  • No federal and state income tax at the time of exercise
  • If held at least two years from the grant date and one year from the exercise date, you will pay long-term capital gains
  • You may owe Alternative Minimum Tax (AMT) on your bargain element
  • AMT is due every quarter
  • ISOs must expire after ten years
  • ISOs are not transferrable.
  • Disqualifying disposition if you sell shares before the 2-year / 1-year period.
  • Eligible for 83b election

Non-Qualified Stock Options (NSOs)

Non-Qualified Stock Options, or NSOs, are another type of employee stock options.  NOSs are more flexible but have less favorable tax treatment than ISOs. Employees can purchase company stock at the exercise price. NSOs are generally taxable as ordinary income at the time of exercise.

  • Less favorable tax treatment
  • The exercise of NSO is a taxable event.
  • All Federal, payroll, and state income taxes are due on the difference between the Fair Market Value (FMV) of your options and exercise cost
  • FMV at exercise will be the cost basis of your shares
  • Long-term capital gains or losses if you hold your shares for more than one year
  • Short-term capital gains or losses if you hold your shares for less than one year
  • Early exercise when you sell your shares immediately after exercise
  • Eligible for 83b election

Restricted Stock Units (RSUs)

RSUs are a form of equity compensation where employees receive a specified number of company shares at a predetermined future date, usually contingent on meeting certain conditions like time-based vesting or performance goals. When RSUs vest, the value of the shares is typically reported as ordinary income and subject to taxation.

  • RSUs are equity grants with a 4-year vesting schedule
  • The entire value of your vested shares is taxable as ordinary income
  • Taxes are withheld at the time of vesting.
  • The default 22% Federal and 10.23% California withholdings
  • Public companies usually sell a portion of your vested shares to cover taxes.
  • You may need to sell additional shares to pay your full tax amount.
  • Long-term capital gains or losses if you hold your shares for more than one year
  • Short-term capital gains or losses if you hold your shares for less than one year
  • Some startups have a dual trigger vesting schedule. Taxes are due at the time of IPO or exit.
  • Not eligible for 83b election

Restricted Stock Awards

Restricted Stock Awards (RSAs) are similar to RSUs, but employees receive actual company shares at the time of grant, which are typically subject to certain restrictions. These restrictions often involve a vesting period or performance targets. When these restrictions are lifted, the value of the shares is usually subject to taxation.

  • RSAs are typically issued to early-stage employees and founders when FMV is very low.
  • Employees pay for their RSAs at a pre-determined price.
  • The difference between the current FMV and the original purchase price is taxable as ordinary income.
  • Long-term capital gains or losses if you hold your shares for more than one year
  • Short-term capital gains or losses if you hold your shares for less than one year
  • Eligible for 83b election

Employee Stock Purchase Plan

An Employee Stock Purchase Plan (ESPP) is a company-sponsored program that allows eligible employees to purchase shares of their employer’s stock at a discounted price. ESPPs are a popular form of employee benefits. They are designed to enable employees to become partial owners of their company while offering potential financial benefits.

  • $25,000 annual limit
  • You purchase the shares at a 15% discount from the market price
  • Lookback feature allows you to buy shares at a lower price between the beginning and end of the period.
  • Shares are not taxable until you sell them
  • You must hold the shares for two years after offering and one year after purchase
  • The discount is taxable as ordinary income
  • You pay long-term capital gains on the difference between the sale and market prices on the acquisition date.

Incorporating Stock Options and RSUs into Retirement Planning

 Understand what you own

First and foremost, before starting to plan for retirement, you must fully understand what type of equity compensation you have.  There are many rules and restrictions concerning stock options and RSUs. Make sure that you follow the rules and use them to your advantage to maximize your financial outcome.

Know your goals

Knowing your financial goals is a critical foundation for effective financial planning. Your goals will serve as your roadmap, guiding your financial decisions and helping you prioritize where you allocate your resources. Whether saving for retirement, buying a new home, funding your children’s education, or making charitable contributions, having clear, well-defined financial objectives allows you to set specific targets and create a strategic plan to reach them. Understanding your financial goals provides motivation, focus, and a sense of purpose in managing your money, ultimately paving the way to financial security and realizing your dreams.

Assess Your Comprehensive Financial Picture

Retirement planning isn’t just about stock options and RSUs. It’s essential to assess your entire financial situation. This includes other assets, liabilities, savings, and expenses. Creating a comprehensive financial plan that integrates all aspects of your financial life, including your stock-based compensation, can help you decide when and how to retire.

Diversification to Manage Concentrated Risk

Stock options and RSUs can lead to concentrated holdings in your employer’s stock. While it’s a sign of confidence in your company, it can also expose your retirement savings to significant risk if your company faces financial difficulties. Diversification is key. As you approach retirement, consider gradually reducing your exposure to your employer’s stock and reallocating your investments into a diversified portfolio to mitigate risk.

Tax Planning

Effective tax planning is crucial when dealing with stock options and RSUs. Depending on the type of assets you hold, you should exercise them or sell them strategically to optimize tax consequences. This often involves balancing the timing of exercising options and selling shares with your overall financial situation and tax bracket.

Seek Professional Guidance

Stock options and RSUs can be valuable assets in your retirement planning strategy. By understanding the different types of stock-based compensation and considering factors like taxation, diversification, and your comprehensive financial situation, you can maximize the benefits of these assets while ensuring a secure retirement. Remember that careful planning, professional guidance, and a long-term perspective are the keys to successfully incorporating stock options and RSUs into your retirement plan.

Given the complexity of stock options, RSUs, and tax implications, it’s often wise to consult with a financial advisor or a tax professional who specializes in equity compensation planning. We can help you navigate the intricacies and make well-informed choices that align with your retirement goals.

Babylon Wealth Management excels in helping employees with stock-based compensation plans for a secure retirement. Our team of experienced financial advisors understands the complexities of stock options, RSUs, ESPPs, and other equity-based incentives. We work closely with clients to develop tailored retirement strategies that maximize the potential benefits of these assets while also mitigating risks. From tax-efficient exercise and sale strategies to diversification techniques and comprehensive financial planning, our experts provide guidance every step of the way. With Babylon Wealth Management, you can confidently navigate the intricacies of stock-based compensation to build a retirement plan that aligns with your financial goals, ensuring a prosperous and worry-free retirement future.

Tax-loss harvesting. How to maximize your after-tax returns.

Tax loss harvesting

What is tax-loss harvesting?

Tax-loss harvesting (TLH) is a strategy that you, as an investor, can use to reduce your capital gains taxes and potentially maximize your future after-tax returns. The TLH strategy involves selling an investment in a taxable account at a loss to offset the taxes on another investment sold for a gain in a different part of your investment portfolio. You can only use the strategy in taxable investment accounts.

For example, let’s say you own 1,000 shares of XYZ stock that you bought for $10 per share. The stock is now trading at $8 per share, so you have a loss of $2 per share. You will realize a $2,000 capital loss if you sell the stock.

Tax-loss harvesting can be a great tool to manage taxes and maximize long-term after-tax returns. It can help you reduce risk in your portfolio and turn losses into wins. According to studies, TLH can contribute up to 1% in after-tax portfolio returns.

A well-executed tax loss harvesting strategy can reduce your current tax bill through tax deferral. That means that you are not only saving money on their taxes in a given year, but you can reinvest those tax savings for potential growth in the future. And the longer your portfolio stays invested in the market, the more time it has to grow and compound.

Long-term capital gains versus short-term capital gains

To understand TLH, you also have to know how the US tax system treats long-term versus short-term capital gains

When you buy and sell an asset with appreciated value, you may have to pay capital gains taxes. The amount of tax you owe will depend on how long you hold the asset before selling it. The gain is considered short-term if you own the asset for one year or less. If you hold the investment for more than one year, the gain is taxable as long-term.

Short-term capital gains

Short-term capital gains are taxable at the same rate as your ordinary income. This means that the higher your income, the higher your capital gains tax rate will be. For example, if you are in the 32% tax bracket, you will pay a 32% capital gains tax on any short-term gains.

Tax Brackets 2023 IRS
Tax Brackets 2023 IRS

Long-term capital gains

Long-term capital gains, on the other hand, are taxable at a lower rate. The exact rate you pay will depend on your income and filing status.

All else equal, holding an appreciated asset for more than one year before selling it is more financially beneficial if you want to pay lower capital gains taxes.

LTCG Tax Brackets 2023 IRS
LTCG Tax Brackets 2023 IRS

Keep in mind that income levels to determine the tax rate for long-term capital gains include income from ALL sources, not just capital gains.

Example 1: You are single and earning $150,000 per year. Also, you have reported a long-term capital gain of $25,000. Your reported income is $175,000, which falls in the 15% tax bracket. Therefore, you must pay a long-term capital gain tax of $3,750 ($25,000 x 15%)

Example 2: You are a retired couple filing jointly. You don’t earn any income but have reported $70,000 in long-term capital gains from your investment portfolio. Since your total reportable income is below the 15% tax threshold, you don’t owe any taxes on your investment gains.

There are a few exceptions to the long-term capital gains tax rates. For example, collectibles such as art, antiques, and jewelry are taxed at a flat 28% rate regardless of how long you hold them.

State taxes

Another layer for the full impact of tax loss harvesting is your state taxes. Some states, like Texas and Florida, do not impose taxes on capital gains. California, New York, and New Jersey treat capital gains as ordinary income regardless of your holding period. A third group of states, like Connecticut and North Carolina, have a flat rate. While state income taxes are typically lower than federal ones, it’s essential to understand the full scope of your tax loss harvesting strategy before moving forward.

Net Investment Income tax

Net investment income tax (NIIT) is a 3.8% surcharge tax on certain types of investment income. It applies to individuals, estates, and trusts with modified adjusted gross income (MAGI) above certain thresholds.

The types of investment income that are subject to NIIT include Interest, Dividends, Capital gains, Rental income, Royalties, Passive income from businesses, and Non-qualified annuities. NIIT does not apply to distributions from retirement accounts, such as IRAs and 401(k)s. Additionally, NIIT does not apply to Social Security benefits, unemployment benefits, or veterans’ benefits.

The MAGI thresholds for NIIT are:

NIIT 2023
NIIT 2023

If your MAGI is above the threshold for your filing status, you will owe NIIT on the lesser of your net investment income or the amount by which your MAGI exceeds the threshold.

What are some of the benefits of tax-loss harvesting?

  • You can reduce your taxes on capital gains in the current and future tax years.
  • Realized capital losses can offset realized capital gains from selling other investments in your portfolio, real estate, private equity, or a business.
  • Tax-loss harvesting can help you lower capital gain taxes from selling stocks from employer incentive stock options (ISOs), nonqualified stock options (NSOs), restricted stock units (RSUs), and restricted stock (RS)
  • You can unload bad investments
  • Turn a loss into a win
  • You can deduct up to $3,000 ($1,500 married filing separately) of capital losses per year against ordinary income.
  • Any residual losses that exceed $3,000 can be carried forward to future years.
  • You can use TLH to diversify your portfolio.
  • It can help you take advantage of market fluctuations and rebalance your investment portfolio.
  • You can use tax loss harvesting to reduce the risk of holding concentrated positions.

What are some of the risks of tax-loss harvesting?

  • You may miss out on future gains if you sell an investment at a loss.
  • You may have to repurchase the investment at a higher price in the future.
  • TLH may trigger a wash sale if you repurchase your investment too soon.
  • You may not be able to offset your losses with gains

Wash Sale Rule

The wash sale rule is an IRS rule that prevents investors from claiming a tax loss on the sale of an investment if they buy the same or substantially identical investment within 30 days before or after the sale. The wash sale rule is designed to prevent investors from artificially inflating their losses in order to reduce their tax liability.

Here is an example of a wash sale:

  • You sell 100 shares of ABC stock at a loss of $1,000.
  • Within 30 days of selling the ABC stock, you buy 100 shares of DEF, which is substantially identical to ABC.
  • You cannot claim the $1,000 loss on the sale of the ABC stock.
  • The loss from the sale of ABC shares is deferred for a later date.
  • The cost basis of DEF stock will adjust with the amount of the capital loss

The wash sale rule applies to a wide range of investments in a taxable account, including stocks, bonds, mutual funds, and ETFs. It also applies to options and futures contracts. The wash sale rule doesn’t currently apply to cryptocurrency, but that could change in the future.

How to make tax loss harvesting work for you

Here are some of the essential requirements and considerations of a successful tax-loss harvesting strategy

  1. Stay invested. When you execute tax loss harvesting, you must continue to invest in the market. Replace the asset you sold at a loss with a similar (but not substantially identical) investment. Leaving the proceeds from the sale on the sidelines can lead to a substantial loss of potential future returns.
  2. Know your goals – tax loss harvesting will be effective only if It is an essential element of your comprehensive financial plan. TLH must be integral to your strategy to achieve your long-term financial goals and milestones.
  3. Avoid breaking the wash sale rule – Not complying with the wash sale rule can lead to confusion and errors. You may not be able to reach the goals of your TLH strategy if you don’t have a proper execution.
  4. Know your investment time horizon – If you plan to hold an investment for the long run, it may not be in your best interest to sell it and harvest losses.
  5. Track your tax bracket – If you are in a higher tax bracket, tax-loss harvesting can be a smart way to reduce your taxes.
  6. Know the overall health of your portfolio. If your portfolio is well diversified, you may not need to use tax-loss harvesting. However, if your portfolio is concentrated in a few stocks or sectors, tax-loss harvesting can help you reduce your risk.
  7. Don’t overdo it – too much TLH activity can draw the attention of the IRS or can prompt mistakes.

Final words

Tax-loss harvesting is a complex strategy. And it’s important to understand the risks and benefits before selling investments at a loss. If you are considering tax-loss harvesting, talking to a financial or tax advisor will ensure you know the full implications of the process. A fiduciary advisor can help you tailor a tax-loss harvesting strategy that is right for you and your financial plan.

Know your tax brackets for 2023

Tax Brackets 2023

There are seven federal tax brackets for the 2023 tax year: 10%, 12%, 22%, 24%, 32%, 35%, and 37%. Every year the IRS modifies the tax brackets for inflation. Your specific bracket depends on your taxable income and filing status. These are the rates for taxes due in April 2024.

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Marginal tax rate

The marginal tax rate is the highest tax rate you have to pay for every additional dollar of income you earn. A 25% marginal tax rate means you will pay 25 cents for every extra dollar you report on your earnings.

Effective Tax Rate

The effective tax rate is your total tax amount divided by your total earned income.

Single Filers Tax Brackets for 2023

Tax rate Taxable income bracket Your taxes
10% $0 to $11,000 10% of taxable income
12% $11,000 to $44,725 $1,100 plus 12% of the amount over $11,000
22% $44,725 to $95,375 $5,147 plus 22% of the amount over $44,725
24% $95,375 to $182,100 $16,290 plus 24% of the amount over $95,375
32% $182,100 to $231,250 $37,104 plus 32% of the amount over $182,100
35% $231,250 to $578,125 $52,832 plus 35% of the amount over $231,250
37% $578,125 or more $174,238.25 plus 37% of the amount over $578,125

Married Filing Jointly Tax Brackets for 2023

Tax rate Taxable income bracket Your taxes
10% $0 to $22,000 10% of taxable income
12% $22,000 to $89,450 $2,200 plus 12% of the amount over $22,000
22% $89,450 to $190,750 $10,294 plus 22% of the amount over $89,450
24% $190,750 to $364,200 $32,580 plus 24% of the amount over $190,750
32% $364,200 to $462,500 $74,208 plus 32% of the amount over $364,200
35% $462,500 to $693,750 $105,664 plus 35% of the amount over $462,500
37% $693,750 or more $186,601.50 plus 37% of the amount over $693,750

Married Filing Separately Tax Brackets for 2023

Tax rate Taxable income bracket Your taxes
10% $0 to $11,000 10% of taxable income
12% $11,000 to $44,725 $1,100 plus 12% of the amount over $11,000
22% $44,725 to $95,375 $5,147 plus 22% of the amount over $44,725
24% $95,375 to $182,100 $16,290 plus 24% of the amount over $95,375
32% $182,100 to $231,250 $37,104 plus 32% of the amount over $182,100
35% $215,951 to $346,875 $52,832 plus 35% of the amount over $231,250
37% $346,875 or more $93,300.75 plus 37% of the amount over $346,875

Head of Household Tax Brackets for 2023

Tax rate Taxable income bracket Your Taxes
10% $0 to $15,700 10% of taxable income
12% $15,700 to $59,850 $1,570 plus 12% of the amount over $15,700
22% $59,850 to $95,350 $6,868 plus 22% of the amount over $59,850
24% $95,350 to $182,100 $14,678 plus 24% of the amount over $95,350
32% $182,100 to $231,250 $35,498 plus 32% of the amount over $182,100
35% $231,250 to $578,100 $51,226 plus 35% of the amount over $231,250
37% $578,100 or more $172,623.50 plus 37% of the amount over $578,100

2023 Standard Deduction

The amount of the standard deduction reduces your taxable income. Usually, the IRS adjusts the standard deduction for inflation every year.

You can choose a standard or itemized deduction when you file your taxes. It only makes sense to itemize your deductions if their total value is higher than the standard deduction.

 

Filing Status Deduction Amount
Single $13,850
Married Filing Jointly $27,700
Head of Household $20,800

Long-term capital gain taxes

You owe a capital gains tax on the profit from selling capital assets such as stocks, options, bonds, real estate, and cryptocurrencies. Long-term capital gains have a more favorable tax treatment than your ordinary taxable income. To qualify for long-term status, you must realize a profit on an investment after holding it for one calendar year or 365 days. Short-term capital gains are taxable as ordinary income.

Taxable Income Over
Tax Rate Single Married Filing Jointly Head of Household
0% $0 $0 $0
15% $44,625 $89,250 $59,750
20% $492,300 $553,850 $523,050

Net Investment Income tax

A net investment income tax of 3.8% applies to all taxpayers with net investment income above specific threshold amounts. In general, net investment income includes

  • Long Term Capital gains
  • Short capital gains
  • Dividends
  • Taxable interest
  • Rental and royalty income
  • Passive income from investments you don’t actively participate in
  • Business income from trading financial instruments or commodities
  • The taxable portion of nonqualified annuity payments

You will pay 3.8% of the smaller value between

  1. Your total net investment income, or
  2. the excess of modified adjusted gross income over the following threshold amounts:
  • $200,000 for single and head-of-household filers
  • $250,000 for married filing jointly or qualifying widow(er)
  • $125,000 for married filing separately

Alternative Minimum Tax Levels for 2023

The AMT exemption amount for 2023 is $81,300 for singles and $126,500 for married couples filing jointly.

In 2023, the 28% AMT rate applies to an excess AMTI of $220,700 for all taxpayers ($110,350 for married couples filing separate returns).

AMT exemptions phase out at 25 cents per dollar earned once AMTI reaches $578,150 for single filers and $1,156,300 for married taxpayers filing jointly.

 

Roth IRA and why you probably need one – Updated for 2022

Roth IRA

Roth IRA is a tax-exempt investment account that allows you to make after-tax contributions to save for retirement. The Roth IRA has a tax-free status. It is a great way to save for retirement and meet your financial goals without paying a dime for taxes on your investments. It offers you a lot of flexibility with very few constraints.

Roth IRA is an excellent starting point for young professionals. It can help you reach your financial goals faster. So open your account now to maximize its full potential. Investing early in your career will lay out the path to your financial independence.

1. Plan for your future

Opening a Roth IRA account is a great way to plan for retirement and build financial independence. This tax-free account is an excellent saving opportunity for many young professionals and anyone with limited access to workplace retirement plans. Even those with 401k plans with their employer can open a Roth IRA.

If you are single and earn $129,000 or less in 2022, you can contribute up to $6,000 per year to your Roth IRA. Individuals 50 years old and above can add a catch-up contribution of $1,000. If you are married and filing jointly, you can contribute the full amount if your MAGI is under $204,000.

There is a phaseout amount between $129,000 and $144,000 for single filers and $204,000 and $214,000 for married filing jointly.

2. No age limit

There is no age limit for your contributions. You can contribute to your Roth IRA at any age as long as you earn income.

Minors who earn income can also invest in Roth IRA. While youngsters have fewer opportunities to make money, many sources of income will count – babysitting, garden cleaning, child acting, modeling, selling lemonade, distributing papers, etc.

3. No investment restrictions

Unlike most 401k plans, Roth IRAs do not have any restrictions on the type of investments in the account. You can invest in any asset class that suits your risk tolerance and financial goals.

4. No taxes

There are no taxes on the distributions from this account once you reach the age of 59 ½. Your investments will grow tax-free. You will never pay taxes on your capital gains and dividends, either. Roth IRA is a great saving tool for investors at all income levels and tax brackets.

With an average historical growth rate of 7%, your investment of $6,000 today could bring you $45,674 in 30 years, completely tax-free. The cumulative effect of your return and the account’s tax status will help your investments grow faster.

If you are a California resident, your maximum tax rate on ordinary income can be over 52.5% – 37%  for Federal taxes, 13.3% for State Taxes, and 2.35% for Medicare. This figure excludes Social security and self-employment tax.

The maximum long-term capital gain tax in the US is 23.68%. California residents could pay up to 13,3% on their capital gains as California doesn’t differentiate between long-term and short-term gains.

5. No penalties if you withdraw your original investment

While not always recommended, Roth IRA allows you to withdraw your original dollar contribution (but not the return) before reaching retirement, penalty and tax-free. Say, you invested $5,000 several years ago. And now the account has grown to $15,000. You can withdraw your initial contribution of $5,000 without penalties.

6. Diversify your future tax exposure

Most of your retirement savings will likely be in a 401k plan or an investment account. 401k plans are tax-deferred, and you will owe taxes on any distributions. Investment accounts are taxable, and you pay taxes on capital gains and dividends. In reality, nobody can predict your tax rate by the time you need to take out money from your retirement and investment accounts. Roth IRA adds this highly flexible tax-advantaged component to your investments.

7. No minimum distributions

Unlike 401k plans, Roth IRA doesn’t have any minimum distributions requirements. Investors can withdraw their savings at their wish or keep them intact indefinitely.

8. Do a backdoor Roth conversion

Due to recent legal changes, investors who do not satisfy the requirements for direct Roth IRA contributions can still make investments in it. The process starts with a taxable contribution, up to the annual limit, into a Traditional IRA. Eventually, the contributions are rolled from the Traditional IRA to the Roth IRA.

9. Roth conversion from Traditional IRA and 401k plans

Under certain circumstances, converting your Traditional IRA and an old 401k plan to Roth IRA could make sense. If you expect to earn less income or pay lower taxes in a particular year, it could be beneficial to consider this Roth conversion. Your rollover amount will be taxable at your current ordinary income tax level. An alternative strategy is to consider annual rollovers in amounts that will keep you within your tax bracket.

10. Estate planning

Roth IRA is an excellent estate planning tool. Due to its age flexibility and no minimum required distributions, it is a good option for generation transfer and leaving a legacy to your beloved ones.

Tax Saving Strategies for 2022

Tax Saving Strategies for 2022

As we approach the end of  2022, I am sharing my favorite list of tax-saving ideas to help you lower your tax bill for 2022. In my experience, the US tax rules change frequently. 2022 was no exception.

2022 has been a tough year for investors. The interest rates are rising, and the stock market is volatile. Since we don’t have any control over the economy, proactive tax planning is essential for achieving your financial goals. Furthermore, it is key to attaining tax alpha. For you,  achieving Tax Alpha is a process that starts on day 1. Making smart tax decisions can help you grow your wealth while you prepare for various outcomes. 

Today, you have an excellent opportunity to review your finances. You can make several smart and easy tax moves to lower your tax bill and increase your tax refund. Being ahead of the curve will help you make well-informed decisions without the stress of tax deadlines. Start the conversation today. 

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1. Know your tax bracket

The first step of managing your taxes is knowing your tax bracket. In 2022, federal tax rates fall into the following brackets depending upon your taxable income and filing status. Knowing where you land on the tax scale can help you make informed decisions, especially when you plan to earn additional income, exercise stock options, or receive RSUs

Here are the Federal tax bracket and rates for 2022.

Tax rate Single Married Filing Jointly Married Filing Separately Head of household
10% $0 to $10,275 $0 to $20,550 $0 to $10,275 $0 to $14,650
12% $10,276 to $41,775 $20,551 to $83,550 $10,276 to $41,775 $14,651 to $55,900
22% $41,776 to $89,075 $83,551 to $178,150 $41,776 to $89,075 $55,901 to $89,050
24% $89,076 to $170,050 $178,151 to $340,100 $89,076 to $170,050 $89,051 to $170,050
32% $170,051 to $215,950 $340,101 to $431,900 $170,051 to $215,950 $170,051 to $215,950
35% $215,951 to $539,900 $431,901 to $647,850 $215,951 to $323,925 $215,951 to $539,900
37% $539,901 or more $647,851 or more $323,926 or more $539,901 or more

2. Decide to itemize or use a standard deduction

The standard deduction is a specific dollar amount that allows you to reduce your taxable income. Nearly 90% of all tax filers use the standard deduction instead of itemizing. It makes the process a lot simpler for many Americans. However, in some circumstances, your itemized deductions may surpass the dollar amount of the standard deduction and allow you to lower your tax bill even further.

Here are the values for 2022:

2022 Standard Deduction  
Filing Status Deduction Amount
Single $12,950
Married Filing Jointly $25,900
Married Filing Separately $12,950
Head of Household $19,400

3. Maximize your retirement contributions

You can save taxes by contributing to a retirement plan. Most contributions to qualified retirement plans are tax-deductible and lower your tax bill.

  • For employees – 401k, 403b, 457, and TSP. The maximum contribution to qualified employee retirement plans for 2022 is $20,500. If you are  50 or older, you can contribute an additional $6,500.
  • For business owners – SEP IRA, Solo 401k, and Defined Benefit Plan. Business owners can contribute to SEP IRA, Solo 401k, and Defined Benefit Plans to maximize their retirement savings and lower their tax bills. The maximum contribution to SEP-IRA and Solo 401k in 2022 is $61,000 or $67,500 if you are 50 and older.

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

In a solo 401k plan, you can contribute as an employee and an employer. The employee contribution is subject to a $20,500 limit plus a $6,500 catch-up. The employer match is limited to 25% of your compensation for a maximum of $40,500. In many cases, the solo 401k plan can allow you to save more than SEP IRA.

A defined Benefit Plan 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. Roth conversion

Transferring investments 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. With stocks in a bear market, 2022 offers an excellent opportunity for Roth conversion and long-term tax planning. 

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

If you believe your taxes will go up in the future, Roth Conversion could be a very effective way to manage your future taxes. 

5. Contribute to a 529 plan

The 529 plan is a tax-advantaged state-sponsored investment plan, allowing 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. The 529 plan has a distinct tax advantage compared to a regular brokerage account, 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 complete list here. Your 529 contributions can significantly lower your state tax bill if you live in these states.

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 lowering your tax bill simultaneously. Your contributions can be in cash, household good, appreciated assets, or directly from your IRA distributions. 

Charitable donations are tax-deductible only when you itemize your tax return. If you make small contributions throughout the year, you might be better off taking the standard deduction.

If itemizing your taxes is crucial, 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. Tax-loss harvesting

The stock market is volatile. If you are holding stocks and other investments that dropped significantly in 2022, you can consider selling them. Selling losing investments to reduce your tax liability is known as tax-loss harvesting. It works for capital assets outside retirement accounts (401k, Traditional IRA, and Roth IRA). Capital assets may include real estate, cryptocurrency, cars, gold, stocks, bonds, and any investment property not for personal use.

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

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 2022:

Long-term capital gains tax rate Single Married Filing Jointly
0% $0 to $41,675 $0 to $83,350
15% $41,675 – $459,750 $83,350 to $517,200
20% Over $459,750 Over $517,200

Furthermore, high-income earners will also pay an additional 3.8% net investment income tax.

9. Contribute to FSA

With healthcare costs constantly increasing, you can use a Flexible Spending Account (FSA)  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 pretax dollars to cover medical and dental expenses for yourself and your dependents. 

The maximum contribution for 2022 is $2,850 per person. If you are married, your spouse can save another $2,850 for a total of $5,700 per family. Some employers offer a matching FSA contribution for up to $500. Typically,  you must use your FSA savings by the end of the calendar year. However, for 2022, the maximum carryover amount is $570

Dependent Care FSA (DC-FSA)

A Dependent Care FSA  is a pretax 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 easy to reduce your tax bill while taking care of your children and loved ones while you continue to work.

The American Rescue Plan Act (ARPA) raised pretax contribution limits for dependent care flexible spending accounts (DC-FSAs) for 2022.   For married couples filing jointly or single parents filing as head of household, the maximum contribution limit is $5,000. 

10. Buy an electric vehicle

if you purchase an electric vehicle with a final assembly in North America, you might be eligible for a Federal tax credit. Many states have separate incentives.  The maximum credit is $7,000 depending on your income, the size of the vehicle, and its battery capacity. All eligible models are subject to a 200,000 EV credit cap. Most Tesla, Bold, and GM have reached the cap. For the most recent list check the US Department of Energy website.

11. Contribute to 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 pretax basis to pay for eligible medical expenses.

Keep in mind that the HSA has three distinct tax advantages.

  1. All HSA contributions are tax-deductible and will lower your tax bill.
  2. Your investments grow tax-free. You will not pay taxes on dividends, interest, and capital gains.
  3. If you use the account for eligible medical expenses, you don’t pay taxes on those withdrawals.

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 $1,400 for an individual and $2,800 for a family. Additionally, your HDHP must have an out-of-pocket maximum of up to $7,050 for one-person coverage or $14,100 for families.

The maximum contributions in HSA for 2022 are $3,650 for individual coverage and $7,300 for families 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.

12. Defer or accelerate income

Is 2022 shaping to be a high income for you? Perhaps, you can defer some of your income from this calendar year into 2022 and beyond. This move will allow you to avoid or delay higher income taxes. Even though it’s not always possible to defer wages, you might be able to postpone a large bonus, royalty, capital gains, or one-time payment. Remember, it only makes sense to defer income if you expect to be in a lower tax bracket next year.

On the other hand, if you expect to be in a higher tax bracket tax year next year, you may consider taking as much income as possible in 2022.

Ten Successful tips for surviving a bear market

Survive bear market

Surviving a bear market can be a treacherous task even for experienced investors. If you are a long-term investor, you know that the bear markets are common. Since 1945, there have been 14 bear markets—or about every 5.4 years. Experiencing a bear market is rough but an inevitable aspect of the economic cycle.

What is a bear market?

A bear market is a prolonged market downturn where stocks fall by 20% or more. Often, bear markets are caused by fears of recession, changes in Fed policy, political uncertainty, geopolitics, or poor macroeconomic data. There have been 26 bear markets in the S&P 500 Index since 1928. However, there have also been 27 bull markets—and stocks have risen significantly over the long term. The average length of a bear market is 289 days or about 9.6 months. For comparison, the average length of a bull market is 991 days or 2.7 years.

A bear market doesn’t necessarily indicate an economic recession. There have been 26 bear markets since 1929, but only 15 recessions during that time. Bear markets often go alongside a slowing economy, but a weakening market doesn’t necessarily mean an imminent recession.

How low can stock go down during a bear market?

Historically, stocks lose 36% on average during a bear market. For comparison, stocks achieve a 114% return on average during a bull market.

The largest-ever percentage drop by the S&P 500 index occurred on October 19, 1987 (known as The Black Monday), when the S&P 500 dropped by -20.47%. The next biggest selloff happened on October 15, 2008, when the S&P 500 lost –9.03%. In both cases, the stock market continued to be volatile for several months before reaching a bottom. Every time, the end of the bear market was the start of a new bull market. Both times, the stock market recovered and reached historic highs in a few years.

What can you do in the next bear market?

The first instinct you may have when during a sharp market drop is to sell your investments. In reality, this may not always be the right move. Selling your stocks during a bear market could limit your losses but also lead to missed long-term opportunities. Emotional decisions do not bring a sustainable long-term outcome.

Dealing with declining stock values and market volatility can be challenging. The truth is nobody likes to lose money. The bear markets can be treacherous for seasoned and inexperienced investors alike. To be a successful investor, you must remain focused on the strength of your portfolio, your goals, and the potential for future growth. I want to share ten strategies that can help you survive the next bear market and preserve the long-term growth of your portfolio.

1. Stay calm during a bear market

Although it can be difficult to watch your stock portfolio decline, it’s important to remember that bear markets have always had a temporary role in the investment process. Those who survive the bear market and make it to the other side can reap huge benefits.

It’s normal to be cheerful when the stock prices are going higher. And it’s even more natural to get anxious during severe bear markets when stocks are going down.

Here is an example of the typical investor experience during a market cycle. The average investor sells near the bottom of the bear market and goes all in at the top of the bull cycle.

Market cycle
 

Significant drops in stock value can trigger panic. However, fear-based selling to limit losses is the wrong move

Overall, markets are positive the majority of the time. Of the last 92 years of market history, bear markets have comprised only about 20.6 of those years. Put another way; stocks have been on the rise 78% of the time.

If you are making sound investment choices, your patience and the ability to tolerate paper losses will earn you more in the long run.

2. Focus on your long-term goals

A market downturn can be tense for all investors. Regardless of how volatile the next bear market correction is, remember that “this too shall pass.”

Market crises come and go, but your goals will most likely remain the same. In fact, your goals have nothing to do with the market. Your investment portfolio is just one of the ways to achieve your goals.

Your personal financial goals can stretch over several years and decades. For investors in their 20s and 30s financial goals can go beyond 40 – 50 years. Even retirees in their 60s must ensure that their money and investments last through several decades.

Remain focused on your long-term goals. Pay off your debt. Stick to a budget. Maintain a high credit score. Live within your means and don’t risk more than you can afford to lose.

3. Don’t try to time the market

Many investors believe that they can consistently time the stock market to buy low and sell high. However, timing the market is a myth.

You need to be right twice

When you try to time the market, you have to make two crucial decisions – when to get in and when to get out. With a small margin of error, you must be consistently right all the time.

Missing the best days

Frequently the market selloffs precede broad market rallies. A V-shape recovery often follows a market correction.

Half of the S&P 500 Index’s best days in the last 20 years occurred during a bear market. Another 28% of the market’s best days took place in the first two months of a bull market—before it was clear a bull market had begun. In other words, the best way to survive a bear market is to stay invested since it’s difficult to time the market’s recovery.

 

Missing the best days of the market
Missing the best days of the market

4. Diversify your portfolio

Diversification is essential for your portfolio preservation and growth. Diversification requires that you spread your investments among different asset classes such as domestic versus foreign stocks, large-cap versus small-cap equity, treasury and corporate bonds, real estate, commodities, precious metals, etc.).

Uncorrelated asset classes react uniquely during market downturns and changing economic cycles. For example, fixed income securities and gold tend to rise during bear markets when stocks fall and investors seek shelter. On the other hand, equities rise during economic expansion and a bull market,

Achieving divarication will lower the risk of your portfolio in the long run. It is the only free lunch you can get in investing.

5. Rebalance your portfolio regularly

Rebalancing your portfolio is a technique that allows your investment portfolio to stay aligned with your long terms goals while maintaining a desired level of risk. Typically, portfolio managers will sell out an asset class that has overperformed over the years and is now overweight. With the sale proceeds, they will buy an underweighted asset class.

Hypothetically, if you started investing in 2010 with a portfolio consisting of 60% Equities and 40% Fixed Income securities, without rebalancing by the end of 2021, you will hold 85% equities and 15% fixed income. Due to the last decade’s substantial rise in the stock market, many conservative and moderate investors may be holding significant equity positions in their portfolios. Rebalancing before a bear market downturn will help you bring your investments to your original target risk levels. If you reduce the size of your equity holdings, you will lower your exposure to stock market volatility.

6. Dollar-cost averaging

Picking the bottom during a bear market is impossible. If you are not willing to invest all your money at once, you can do it over a period of time. By using the dollar-cost averaging method, you invest your cash in smaller amounts at regular intervals, regardless of the movements in the market. When the stock market is down, you buy more shares. And it’s up you buy fewer shares.

If you regularly contribute to your 401k, you are effectively dollar-cost averaging.

Dollar-cost averaging takes the emotion out of investing. It prevents you from trying to time the market by requiring you to invest the same amount regardless of the market’s conditions.

7. Use tax-loss harvesting during bear markets

Tax-loss harvesting is a tax and investment technique that allows you to sell off stocks and other assets that have declined to offset current or future gains from other sources. You can then replace this asset with a similar but identical investment during a bear market to position yourself for future price recovery. Furthermore, you can use up to $3,000 of capital losses as a tax deduction from your ordinary income. Finally, you can carry forward any remaining losses for future tax years.

To take advantage of this option, you must follow the wash sale rule. You cannot purchase the same security in the next 30 days. To stay invested in the market, you can substitute the stock with another stock that has a similar profile or buy an ETF

The actual economic value of tax-loss harvesting lies in your ability to defer taxes into the future. You can think of tax-loss harvesting as an interest-free loan by the government, which you will pay off only after realizing capital gains. Therefore, the ability to generate long-term compounding returns on TLH strategy can appeal to disciplined long-term investors with low to moderate trading practices.

8. Roth Conversion

A bear market creates an excellent opportunity to do Roth Conversion. Roth conversion is transferring Tax-Deferred Retirement Funds from a Traditional IRA or 401k plan to a tax-exempt Roth IRA. The Roth conversion requires paying upfront taxes with the objective of decreasing your future tax burden.

The lower stock prices during a bear market will allow you to transfer a larger portion of your investments while paying lower taxes. For more about the benefits of Roth IRA read here. And for more information about Roth conversion, you can read our Roth conversion article.

9. Keep your emergency fund

I always recommend that my clients and blog readers keep at least six months of essential living expenses in a checking or a savings account. We call it an emergency fund. It’s rainy-day money, which you need to keep aside for crises and unexpected life events. Sometimes bear markets coincide with recessions and layoffs. If you lose your job, you will have enough reserves to cover your essential expenses and stay on your feet. Using your cash reserves will help you avoid dipping into your retirement savings.

10. Be opportunistic and invest

Bear markets create lifetime opportunities for buying stocks at discounted prices. One of the most famous quotes by Warren Buffet is, “When it’s raining gold, reach for a bucket, not a thimble.” Bear market selloffs rarely reflect the real long-term value of a company as they are triggered by panic, negative news, or geopolitical events. For long-term investors, bear markets present an excellent opportunity to buy their favorite stocks at a discounted price. If you want to get in the market after a selloff, look for established companies with strong secular revenue growth, experienced management, a strong balance sheet, and a proven track record of paying dividends or returning money to shareholders.

Final words

A bear market can take a massive toll on your emotions, investments, and retirement savings. The lack of reliable information and the instant spread of negative news can influence your judgment and force you to make rash decisions. Bear market selloffs can challenge even the most experienced investors. Don’t allow yourself to panic even if it seems like the world is falling apart. Prepare for the next market downturn by following my list of ten recommendations. This checklist will help you “survive” the next bear market while still following your long-term financial goals.

Inflation is a tax and how to combat it

Inflation is a tax

Inflation is a tax. Let me explain. Inflation reduces the purchasing power of your cash and earnings while simultaneously redistributing wealth to the federal government.

When prices go up, we pay a higher sales tax at the grocery store, restaurants, or gas stations. Even if your employer adjusts your salary with Inflation, the IRS tax brackets may not go up at the same pace. Many critical tax deductions and thresholds are not adjusted for inflation.

For example, the SALT deduction remains at $10,000.

We have a $750,000 cap on total mortgage debt for which interest is tax-deductible. There is a $500,000 cap on tax-free home sales. We also have a  $3,000 deduction of net capital losses against ordinary income such as wages.

The income thresholds at which 85% of Social Security payments become taxable aren’t inflation-adjusted and have been $44,000 for joint-filing couples and $34,000 for single filers since 1994

And lastly, even if interest rates on your savings account go up, you still have to pay taxes on your modest interest earnings.

Effectively we ALL will pay higher taxes on our future income

Here are some strategies that can help you combat Inflation.

(Not) keeping cash

Inflation is a tax on your cash. Keeping large amounts of cash is the worst way to protect yourself against Inflation. Inflation hurts savers. Your money automatically loses purchasing power with the rise of Inflation.

Roughly speaking, if this year’s Inflation is 8%, $100 worth of goods and services will be worth $108 in a year from now. Therefore, someone who kept their cash in the checking account will need an extra $8 to buy the same goods and services he could buy for $100 a year ago.

Here is another example. $1,000 in 2000 is worth $1,647 in 2022. If you kept your money in your pocket or a checking account, you could only buy goods and services worth $607 in 2000’s equivalent dollars

I recommend that you keep 6 to 12 months’ worth of emergency funds in your savings account, earning some interest. You can also set aside money for short-term financial goals such as buying a house or paying off debt. If you want to protect yourself from inflation, you need to find a different destination for your extra cash.

Investing in Stocks

Investing in stocks often provides some protection against Inflation. Stock ownership offers a tangible claim over the company’s assets, which will rise in value with Inflation. In inflationary environments, stocks have a distinct advantage over bonds and other investments. Companies that can adjust pricing,  whereas bonds, and even rental properties, not so much

Historical data has shown that equities perform better with inflation rates under 0 and between 0 and 4%.

Inflation is a tax
Higher Inflation deteriorates firms’ earnings by increasing the cost of goods and services, labor, and overhead expenses. Elevated inflation levels can suppress demand as consumers adjust to the new price levels.

Inflation is a tax

Historically, energy, staples, health care, and utility companies have performed relatively better during high inflation periods, while consumer discretionary and financials have underperformed.

While it might seem tempting to think specific sectors can cope with Inflation better than others, the success rate will come down to the individual companies’ business model. Firms with strong price power and inelastic product demand can pass the higher cost to their customers. Furthermore, companies with strong balance sheets, low debt, high-profit margins, and steady cash flows perform better in a high inflation environment.

You also need to remember that every economic regime is somewhat different. Today, we are less dependent on energy than we were in the 1970s. Corporate leadership is also different. Companies like Apple and Google have superiorly high cash flow margins, low debt, and a smaller physical footprint. Technology plays a more significant role in today’s economy than in the other four inflationary periods.

Investing in Real Estate

Real Estate very often comes up as a popular inflation hedge. In the long-run real estate prices tend to adjust with inflation depending on the location. Investors use real estate to protect against inflation by capitalizing on cheap mortgage interest rates, passing through rising costs to tenants.

However, historical data and research performed the Nobel laureate Robert Shiller show otherwise. Shiller says, “Housing traditionally is not a great investment. It takes maintenance, depreciates, and goes out of style”. On many occasions, it can be subject to climate risk – fires, tornados, floods, hurricanes, and even volcano eruptions if you live on the Big Island. The price of a single house also can be pretty volatile. Just ask the people who bought their homes in 2007, before the housing bubble.

Investors seeking inflation protection with Real Estate must consider their liquidity needs. Real Estate is not a liquid asset class. It takes a longer time to sell it than a stock. Every transaction involves paying fees to banks, lawyers, and real estate agents. Additionally, there are also maintenance costs and property taxes. Rising Inflation will lead to higher overhead and maintenance costs, potential renter delinquency, and high vacancy.

Investing in Gold and other commodities

Commodities and particularly gold, tend to provide some short-term protection against Inflation. However, this is a very volatile asset class. Gold’s volatility, measured by its 50-year standard deviation, is 27% higher than that of stocks and 3.5 times greater than the volatility of the 10-year treasury. Other non-market-related events and speculative trading often overshadow short-term inflation protection benefits.

Furthermore,  gold and other commodities are not readily available to retail investors outside the form of ETFs, ETNs, and futures. Buying actual commodities can incur significant transaction and storage costs, making it almost prohibitive for individuals to own them physically.

In recent years the relationship between gold and Inflation has weakened. Gold has become less crucial for the global economy due to monetary policy expansion, benign economic growth, and low and negative interest rates in Japan and the EU.

 Having a Roth IRA

If higher Inflation means higher taxes, there is no better tool to lower your future taxes than Roth IRA. I have written a lot about why you need to establish a Roth IRA. Roth IRA is a tax-exempt retirement savings account that allows you to make after-tax dollars. The investments in your Roth IRA grow tax-free, and all your earnings are tax=emept.

If you are a resident of California, the highest possible tax rate you can pay are

  • 37% for Federal Income taxes
  • 13.3% for State Income taxes
  • 2% for Social Security Income tax for income up to $147,000 in 2022
  • 35% for Medicare Taxes
  • 20% Long-term capital gain tax
  • 8% for Net Investment income tax (NIIT) for your MAGI is over $200,000 for singles and $250,000 for married filing jointly

Having a Roth IRA helps you reduce the  tax noise on your earnings and improves the tax diversification of your investments

Here is how to increase your Roth contributions depending on your individual circumstances:

  • Roth IRA contributions
  • Backdoor Roth contributions
  • Roth 401k Contributions
  • Mega-back door 401k conversions
  • Roth conversions from your IRA

Tax brackets for 2022

Income Tax Brackets for 2022

There are seven federal tax brackets for the 2022 tax year: 10%, 12%, 22%, 24%, 32%, 35% and 37%. Every year the IRS modifies the tax brackets for inflation. Your specific bracket depends on your taxable income and filing status. These are the rates for taxes due in April 2023.

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Marginal tax rate

The marginal tax rate is the highest tax rate you have to pay for every additional dollar of income you earn. A 25% marginal tax rate means that you will pay 25 cents of every extra dollar you report on your earnings.

Effective Tax Rate

The effective tax rate is your total tax amount divided by your total earned income.

Single Filers Tax Brackets for 2022

Tax rate Taxable income bracket Your taxes
10% $0 to $10,275 10% of taxable income
12% $10,276 to $41,775 $1,027.50 plus 12% of the amount over $10,275
22% $41,776 to $89,075 $4,807.50 plus 22% of the amount over $41,775
24% $89,076 to $170,050 $15,213.50 plus 24% of the amount over $89,075
32% $170,051 to $215,950 $34,647.50 plus 32% of the amount over $170,050
35% $215,951 to $539,900 $49,335.50 plus 35% of the amount over $215,950
37% $539,901 or more $162,718 plus 37% of the amount over $539,900

Married Filing Jointly Tax Brackets for 2022

Tax rate Taxable income bracket Your taxes
10% $0 to $20,550 10% of taxable income
12% $20,551 to $83,550 $2,055 plus 12% of the amount over $20,550
22% $83,551 to $178,150 $9,615 plus 22% of the amount over $83,550
24% $178,151 to $340,100 $30,427 plus 24% of the amount over $178,150
32% $340,101 to $431,900 $69,295 plus 32% of the amount over $340,100
35% $431,901 to $647,850 $98,671 plus 35% of the amount over $431,900
37% $647,851 or more $174,253.50 plus 37% of the amount over $647,850

Married Filing Separately Tax Brackets for 2022

Tax rate Taxable income bracket Your taxes
10% $0 to $10,275 10% of taxable income
12% $10,276 to $41,775 $1,027.50 plus 12% of the amount over $10,275
22% $41,776 to $89,075 $4,807.50 plus 22% of the amount over $41,775
24% $89,076 to $170,050 $15,213.50 plus 24% of the amount over $89,075
32% $170,051 to $215,950 $34,647.50 plus 32% of the amount over $170,050
35% $215,951 to $323,925 $49,335.50 plus 35% of the amount over $215,950
37% $323,926 or more $87,126.75 plus 37% of the amount over $323,925

Head of Household Tax Brackets for 2022

Tax rate Taxable income bracket Your Taxes
10% $0 to $14,650 10% of taxable income
12% $14,651 to $55,900 $1,465 plus 12% of the amount over $14,650
22% $55,901 to $89,050 $6,415 plus 22% of the amount over $55,900
24% $89,051 to $170,050 $13,708 plus 24% of the amount over $89,050
32% $170,051 to $215,950 $33,148 plus 32% of the amount over $170,050
35% $215,951 to $539,900 $47,836 plus 35% of the amount over $215,950
37% $539,901 or more $161,218.50 plus 37% of the amount over $539,900

2022 Standard Deduction

The amount of the standard deduction reduces your taxable income. Usually, the IRS adjusts the standard deduction for inflation every year.

When you file your taxes, you have the option to choose a standard deduction or itemized deductions. It only makes sense to itemize your deductions if their total value is higher than the standard deduction.

 

Filing Status Deduction Amount
Single $12,950
Married Filing Jointly $25,900
Head of Household $19,400

Long-term capital gain taxes

You owe a capital gains tax on the profit made from selling capital assets such as stocks, options, bonds, real estate, and cryptocurrencies. Long-term capital gains have a more favorable tax treatment than your ordinary taxable income. To qualify for the long-term status, you must realize a profit on an investment after holding it for one calendar year or 365 days. Short-term capital gains are taxable as ordinary income

Taxable Income Over
Tax Rate Single Married Filing Jointly Head of Household
0% $0 $0 $0
15% $41,675 $83,350 $55,800
20% $459,750 $517,200 $488,500

Net Investment Income tax

Net Investment income tax of 3.8% applies to all taxpayers with net investment income above specific threshold amounts. In general, net investment income includes

  • Long Term Capital gains
  • Short capital gains
  • Dividends
  • Taxable interest
  • Rental and royalty income
  • Passive income from investments you don’t actively participate in
  • Business income from trading financial instruments or commodities
  • The taxable portion of nonqualified annuity payments

You will pay 3.8% of the smaller value between

  1. Your total net investment income, or
  2. the excess of modified adjusted gross income over the following threshold amounts:
  • $200,000 for single and head of household filers
  • $250,000 for married filing jointly or qualifying widow(er)
  • $125,000 for married filing separately

Choosing between RSUs and stock options in your job offer

RSUs and stock options

RSUs and stock options are the most popular equity compensation forms by both early-stage start-ups and established companies. If you receive equity compensation from your employer, there is a good chance that you own a combination of different equity grants. RSUs and stock options have some similarities as wells as many differences in tax treatment and potential upside. Sometimes your new employer may offer you the opportunity to choose between having RSUs or stock options. Or you already own a mix of them. The purpose of this article is to describe how each compensation works. You will learn how they affect your taxes and how to plan for future upside.

What are RSUs?

RSUs (Restricted Stock Units) are a type of equity compensation in the form of company stock. Typically, your employer will grant you a specific number of shares that will vest over a particular period. The classic vesting schedule is four years with a first-anniversary cliff equal to 25%.  The remaining shares will vest gradually on either a monthly, quarterly, or annual basis.

Taxes on RSUs

RSUs are taxable as ordinary income. Every time your RSUs vest, the fair market value of your shares will be added to your W2 earnings. The employer must withhold Federal and State income tax. In most cases, public companies will sell a portion of your shares to cover all taxes. In the end, you will own a smaller number of shares than your original grant.

Example. You have 1,000 RSUs of company XYZ, which get vested tomorrow.  The fair market value is $10. Therefore $10,000  [1,000 x 10) will be added to your payroll. To cover all Federal income, FICA, and state taxes, the company will sell 300 shares from the total. The proceeds of $3,000 will be used to cover your tax obligations. You can keep 700 shares which you can either sell immediately or keep long term.

If you hold and sell your RSUs before the 1st anniversary of their vesting, all potential gains will be taxable as short-term capital gains.

If you hold and sell your RSUs for longer than one year after vesting, all potential gain will be taxable as long-term capital gains

Double Trigger RSUs

Many private Pre-IPO companies would offer double-trigger RSUs. These types of RSUs are taxable under two conditions:

  1. Your RSUs are vested
  2. You experience a liquidity event such as an IPO, tender offer, or acquisition.

You will not owe taxes on any double-trigger RSUs at your vesting date. However, you will pay taxes on ALL your vested shares on the day of your liquidity event.

What are stock options?

Employee stock options are another type of equity compensation that gives you the right but not obligation to purchase a specific number of company’s shares at a pre-determined price.

Incentive stock options (ISOs)

ISOs are a type of employee stock option with preferential tax treatment. They can only be granted to current employees. You can receive up to $100,000 of ISOs every year. If your total grant exceeds $100,000, you will receive the difference as Non-qualified stock options (NSOs). Most ISOs and NSOs grants will have a 4-year vesting schedule with a one-year cliff. For more information about ISOs, check out this article.

Taxes on ISOs

The vesting and exercise of ISOs do not trigger income taxes.

If you hold your ISOs for two years from the grant date and one year from the exercise date, you will owe long-term capital gains of the difference between the sale and exercise price.

AMT

The exercise of ISOs may cause paying Alternative Minimum Tax (AMT). The AMT is an alternative tax system that is calculated in parallel with your regular taxes. The bargain element or economic benefit of your exercise equals the difference between the Fair Market Value (FMV) and the exercise price of your shares. The AMT formula adds the bargain element to your regular income and calculates a minimum tax rate. If the AMT value is higher than your regular income, you will have to pay the difference to the IRS.

The probability of paying AMT increases as the gap between your shares’ Fair Market Value (FMV) and exercise price widens.

It is crucial to remember that the AMT is a future tax credit. You can potentially recoup all of it. Every year when your AMT dues are lower than your regular taxes, you will receive a tax rebate until you deplete the entire credit.

Non-qualified stock options (NSOs)

NSOs are another type of employee stock option. However, they lack the preferential tax treatment of ISOs. Furthermore, NSOs can be granted to a broader group of stakeholders. For more information about NSOs check out this article.

Taxes on NSOs

The exercise of ISOs triggers Federal and state income taxes. The difference between your shares’ Fair Market Value (FMV) and the exercise cost is taxable as compensation income. Whether your employer is a public company or a startup, you will be responsible for paying the taxes due from the option exercise.

How to choose between RSUs and stock options in your job offer

There is a rule of thumb that 1 RSU is equal to 3 or 4 stock options. Most companies that give you a choice between RSUs and stock options will likely offer you a similar ratio. Let’s discuss some of the key factors that can help you choose between the different grant types.

Public versus private company

Private companies and startups tend to gravitate towards offering ISOs and double-trigger RSUs. These two equity compensation types require the lowest financial commitment from the employees before any liquidity event or an IPO.

Public companies tend to offer traditional RSUs and employee stock purchase plans (ESPPs). You can read more about ESPPs here. Many recent public companies will maintain legacy stock options from their startup stage but will not issue new grants.

Early-stage vs. established startups

Early-stage startups with fewer employees usually give generous ISO grants at below a dollar per shares valuations. The shares are often worth a few cents. These grants offer the biggest upside if the venture becomes successful down the road. Exercising your shares early will allow you to avoid or minimize AMT and pay long-term capital gains when selling your shares in the future. The biggest downside of an early startup is that your first liquidity event might be years away. You may not see a windfall for a long time.

More mature or pre-IPO startups might offer a wider range of equity compensation types. If you join those companies, you may end up owning a mix of ISOs, NSOs, and RSUs. Working for a more established startup, you will be closer to a liquidity event. But the cost of your stock options will be a lot higher. You may have a chance to sell your share through a tender offer or a pending IPO.

Sometimes your company may get acquired by a larger firm. When that happens, your stock options and RSUs will be converted to the acquiring company’s stock.

Liquidity and cash

Owning RSUs generally requires spending less upfront cash. Your company will pay your taxes by selling a portion of your shares on the open market. You don’t have to dip in your checking account.

Both ISOs and NSOs require paying your exercise cost out of pocket. You also may owe taxes or AMT on the transaction.

Cashless exercise

In some cases, employers offer a cashless exercise either through a tender offer or post-IPO.  If you are opt-in for a cashless exercise of your ISOs, they will lose their preferential tax treatment and automatically turn into NSOs.

With a cashless exercise, you exercise your shares and immediately sell them to the buyer. If your firm is private, the buyer can be the company itself or an external investor. If your company is public, you will sell your shares on the stock market.

The exercise cost of your shares will be subtracted from the total value of the proceeds after the sale. Sometimes your payroll department will withhold taxes automatically. Otherwise, you will be responsible for paying taxes on your gains.

The upside potential of RSUs and stock options

From a risk-reward perspective, traditional RSUs offer a lower risk relative to stock options. You can get more predictable payouts if you choose to receive RSUs or NSOs from a public company.

In contrast, owning stock options of an early-stage startup offer a higher risk/reward upside potential. At the same time, your financial outcome is a lot more uncertain. Your windfall will depend on your company’s success in addition to your strategy to exercise your shares early, well in advance of any liquidity events.

Waiting to exercise your ISOs after receiving a tender offer or going public can create issues with paying extremely high AMT and reducing your financial upside by paying higher taxes.

Final words

In closing, the benefits of owning RSUs and stock options will depend on the odds of your company running a successful business model, getting acquired, or going public. There is a massive range of financial outcomes depending on when you exercise your shares, your investment horizon, risk tolerance, cash savings, tax situation, and a little bit of luck. If you want to get the most out of your ISOs, NSOs and RSUs, you need to plan proactively. The decisions that you take today will impact what you keep in your pocket years down the road.

Achieving tax alpha and higher after tax returns on your investments

Achieving Tax Alpha

What is tax alpha?

Tax Alpha is the ability to achieve an additional return on your investments by taking advantage of a wide range of tax strategies as part of your comprehensive wealth management and financial planning.  As you know, it is not about how much you make but how much you keep. And tax alpha measures the efficiency of your tax strategy and the incremental benefit to your after-tax returns.

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Why is tax alpha important to you?

The US has one of the most complex tax systems in the world. Navigating through all the tax rules and changes can quickly turn into a full-time job. Furthermore, the US budget deficit is growing exponentially every year. The government expenses are rising. The only way to fund the budget gap is by increasing taxes, both for corporations and individuals.

Obviously, our taxes pay our teachers, police officers, and firefighters, fund essential services, build new schools and fix our infrastructure. Our taxes help the world around us humming.  However, there will be times when taxes become a hurdle in your decision process. Taxes turn into a complex web of rules that is hard to understand and even harder to implement.

Achieving tax alpha is critical whether you are a novice or seasoned investor sitting on significant investment gains.  Making intelligent and well-informed decisions can help you improve the after-tax return of your investment in the long run.

Assuming that you can generate 1% in excess annual after-tax returns over 30-year, your will investments can grow as much as 32% in total dollar amount.

Tax alpha returns
Tax alpha returns

1. Holistic Financial Planning

For our firm, achieving Tax Alpha is a process that starts on day 1. Making smart tax decisions is at the core of our service. Preparing you for your big day is not a race. It’s a marathon.  It takes years of careful planning and patience. There will be uncertainty. Perhaps tax laws can change. Your circumstances may evolve. Whatever happens, It’s important to stay objective, disciplined, and proactive in preparing for different outcomes.

At our firm, we craft a comprehensive strategy that will maximize your financial outcome and lower your taxes in the long run. We start by taking a complete picture of your financial life and offer a road map to optimize your tax outcome. Achieving higher tax alpha only works in combination with your holistic financial plan. Whether you are planning for your retirement, owning a large number of stock options, or expecting a small windfall, planning your future taxes is quintessential for your financial success.

2. Tax Loss Harvesting

Tax-loss harvesting is an investment strategy that allows you to sell off assets that have declined in value to offset current or future gains from other sources. You can then replace this asset with a similar but identical investment to position yourself for future price recovery. Furthermore, you can use up to $3,000 of capital losses as a tax deduction to your ordinary income. Finally, you can carry forward any remaining losses for future tax years.

The real economic value of tax-loss harvesting lies in your ability to defer taxes into the future. You can think of tax-loss harvesting as an interest-free loan by the government, which you will pay off only after realizing capital gains.  Therefore, the ability to generate long-term compounding returns on TLH strategy can appeal to disciplined long-term investors with low to moderate trading practices.

How does tax-loss harvesting work?

Example: An investor owns 1,000 shares of company ABC, which she bought at $50 in her taxable account. The total cost of the purchase was $50,000. During a market sell-off a few months later, the stock drops to $40, and the initial investment is now worth $40,000.

Now the investor has two options. She can keep the stock and hope that the price will rebound. Alternatively,  she could sell the stock and realize a loss of $10,000. After the sale, she will have two options. She can either buy another stock with a similar risk profile or wait 30 days and repurchase ABC stock with the proceeds. By selling the shares of ABC, the investor will realize a capital loss of $10,000. Assuming she is paying 15% tax on capital gains, the tax benefit of the loss is equal to $1,500.  Furthermore, she can use the loss to offset future gains in her investment portfolio or other sources.

3. Direct Indexing

Direct indexing is a type of index investing. It combines the concepts of passive investing and tax-loss harvesting. The strategy relies on the purchase of a custom investment portfolio that mirrors the composition of an index.

Similar to buying an index fund or an ETF, direct indexing requires purchasing a broad basket of individual stocks that closely track the underlying index.  For example, if you want to create a portfolio that tracks S&P 500, you can buy all or a smaller number of  500 stocks inside the benchmark.

Owning a basket of individual securities offers you greater flexibility to customize your portfolio.  First, you can benefit from tax-loss harvesting opportunities by replacing stocks that have declined in value with other companies in the same category. Second, you can remove undesirable stocks or sectors you otherwise can’t do when buying an index fund or an ETF. Third, direct indexing can allow you to diversify your existing portfolio and defer realizing capital gains, especially when you hold significant holdings with a low-cost basis.

4. Tax Location

Tax location is a strategy that places your diversified investment portfolio according to each investment’s risk and tax profile. In the US, we have a wide range of investment and retirement accounts with various tax treatments. Individual investment accounts are fully taxable for capital gains and dividends. Employer 401k, SEP IRA and Traditional IRA are tax-differed savings vehicles. Your contributions are tax-deductible while your savings grow tax-free. You only pay taxes on your actual retirement withdrawals. Finally, Roth IRA, Roth 401k, and 529 require pre-tax contributions, but all your future earnings are tax-exempt. Most of our clients will have at least two or more of these different instrument vehicles.

Now, enter stocks, bonds, commodities, REITs, cryptocurrencies, hedge funds, private investments, stock options, etc. Each investment type has a different tax profile and carries a unique level of risk.

At our firm, we create a customized asset allocation for every client, depending on their circumstances and goals. Considering the tax implications of each asset in each investment or retirement account, we carefully create our tax location strategy to take advantage of any opportunities to achieve tax alpha.

5. Smart tax investing

Smart tax investing is a personalized investment strategy that combines various portfolio management techniques such as tax-loss harvesting, asset allocation, asset location, diversification, dollar-cost averaging, passive vs. active investing, and rebalancing.  The main focus of tax-mindful investing is achieving a higher after-tax return on your investment portfolio. Combined with your comprehensive financial planning, smart-tax investing can be a powerful tool to elevate your financial outcome.

Step by Step Guide to Planning for Early Stock Option Exercise

Early Stock Option Exercise

Planning for Early Stock Option Exercise can be overwhelming and challenging. if you are one of the many employees of early-stage startups and private companies who receive equity compensation in the form of stock options and RSUs., this article will give you a starting point.

Planning for Early Stock Option Exercise

You probably want to understand how owning stock options will impact your long-term wealth.  The exact specifics of your equity compensation will vary widely from one company to another. There is also a vast range of possible outcomes regarding the value of your equity and the timing of your liquidity event. Your tax implications depend on when and how you exercise your stock options and how long you hold your vested stocks. Furthermore, many employees will struggle with the high concentration of your net worth in a single company.  Burdened with many questions and a few answers, tech workers often delay early stock option exercise until closer to an IPO or other liquidity event.

So, what do you do next? Here are some ideas that can help you navigate the complex world of equity compensation and early stock option exercise.

1. Know what you own

The best way to master your equity ownership is to take a step back and figure what you own. Reach out to your payroll department or stock option vendor and ask for more information about your stock option holdings.

In general, there are two types of employee stock options – Incentive Stock Options (ISOs) and Non-Qualified Stock Options (NSOs). You will most likely own one or the other or some combination of the two. While they may look very similar on the surface, there are significant financial and tax differences between ISOs and NSOs.

ISOs, generally, offer a more favorable tax treatment. There are no taxes due upon your ISO’s exercise, but that can force you to pay an Alternative Minimum Tax.

In comparison, NSOs offer slightly little more flexibility but trigger an immediate taxable income at exercise. Both employers and other stakeholders can receive NSOs.

2. Keep track of key dates and figures

Keeping track of important dates and figures is the next step in mastering your stock options. In most cases, you must start from the moment you receive your job offer. In my article “Guide to understanding your job offer with stock options,” I discuss evaluating a job offer that includes a combination of salary and stock options. There are a handful of important dates and figures that you need to keep track of. Here is the alphabet of terms you have to remember – a number of shares, vesting dates, exercise dates, strike price, fair market value, and vested versus unvested shares.

Furthermore, as you continue working for the same firm, you may receive other stock option grants with different strike prices.  Create a spreadsheet or use the information provided by your option vendor to track all the numbers. It could be cumbersome, but it can help immensely when making early stock options exercise decisions.

3. 83b election

Some companies may allow you for IRC § 83(b) election.  This IRS rule permits companies to offer an early exercise of stock options. When making this election, you will pay income taxes on the fair value of your stock options. The early election is incredibly lucrative for founders and employers of early-stage startups with low fair market value.

The 83(b) election is rarely done due to the complexities in calculating the value of an early-stage startup’s options. If you can determine the value at the time of the grant and decide to pursue this road, you will owe taxes on your options’ fair market value at the grant date. But no income tax will be due at the time of vesting. Another disadvantage of this strategy is the risk of the employee stock price falling below the grant date level. In this scenario, it would have been advantageous to wait until the vesting period.

4. Navigate your taxes

Managing and planning your taxes is by far the most challenging step in the process of early stock option exercise. The biggest hurdle comes from the uncertainty about having enough cash to cover your tax expense. Further on, frequent changes in the company’s fair market value and inability to sell vested shares complicate the process of planning your taxes.

Given so many moving parts, you are probably wondering what your best course of action is. For one, once you reach this junction, it is time to ditch Turbo Tax (no offense, I used it for many years in the past) and seek expert advice. Despite all uncertainty about the future, we advise our clients to start making regular tax projections. Taking a snapshot of your current circumstances will allow you to take an objective view of your finances and make informed financial decisions.

5. Plan ahead for Early Stock Option Exercise

In my practice, I often speak with folks whose company is going public in a matter of days or weeks. A good number of them are considering exercising their stock options for the first time.

There is a strong appeal to do nothing until you approach a significant liquidity event. Waiting to exercise until the IPO eliminates a lot of financial and business uncertainty. However, the waiting strategy has a notable trade-off – paying higher taxes in the future and exposing yourself to material concentration risk.

The advice we give to all our clients is to plan ahead. Do not leave these critical financial decisions for the last minute. Even with the broad range of future outcomes, you could minimize your taxes and reduce your anxiety levels by taking small, measured steps.

What makes the Early Stock Option Exercise decisions so tricky is that no magic formula or one-size-fits-all solution works for everyone. While working with numerous clients, I realize that we all face different circumstances and challenges. If one approach works wells for your colleagues, it may not work very well for you. When we work with our clients, we try to strike the right balance between managing uncertainty and planning for the future.

Effective Roth Conversion Strategies for Tax-Free Growth

Roth Conversion

Roth conversion of your tax-deferred retirement savings can be a brilliant move. Learn the must-know rules and tax implications of Roth Conversion before you decide if it is right for you.

Retirement Calculator

What is a Roth Conversion?

Roth Conversion is the process of transferring the full or partial balance of your existing traditional IRA into a Roth IRA. The conversion effectively moves tax-deferred retirement savings into tax-exempt dollars.

A critical downside of Roth conversion is that you need to pay income taxes on the converted amount. For that reason, it is beneficial to have additional taxable savings to cover the tax cost of the conversion.

Unfortunately, not everybody is the right candidate for Roth conversion. Consider your specific financial and tax circumstances before moving forward.

Watch your tax bracket

A crucial element of any Roth conversion decision making is your taxes. The strategy becomes feasible during low tax years or whenever you expect higher tax rates in the future. Higher future tax rates make a Roth IRA more appealing, while lower future tax rates would make a traditional IRA more attractive.

Consider your investment horizon

Generally, you will achieve a higher benefit if you perform your conversions earlier. Your Roth IRA will have time to grow tax-free for longer and will offset the cost of paying taxes upfront. 

Roth IRA 5-year rule

When you do a Roth conversion, you need to be mindful of the 5-year rule. The rule requires that 5 years have passed since your first Roth contributions before taking penalty-free withdrawals of your tax-free earnings.

You can still withdraw your original contributions at any time. However, your earnings are subject to the 5-year minimum restriction. If you do not meet the minimum 5-year holding period, your profits can be subject to ordinary income tax as well as a 10% penalty for early withdrawal.

Furthermore, each separate Roth conversion has a five-year limit. The Five-Year clock begins ticking on January 1st of the year when you make the conversion.

The advantages of Roth conversion

Converting your tax-deferred dollars to Roth RIA can have several financial and estate benefits.

Your money grows tax-free

Savings in your Roth IRA grow tax-free. As long as you meet the 5-year rule, you will not owe any taxes on your distributions. Roth IRA contributions are pre-tax. You are paying taxes beforehand but do not owe taxes on any future earnings.

In comparison, contributions to Traditional IRA are typically tax-deductible. When you take distributions from Traditional IRA, you have to pay ordinary income taxes on your entire withdrawal amount. 

Tax Diversification

If your future tax rate is uncertain for various reasons, you may want to diversify your tax risk through Roth conversion. You will benefit from holding both tax-deferred and tax-exempt retirement accounts. Tax diversification gives you more flexibility when it comes to future retirement withdrawals and tax planning. 

Asset Location

Asset location is a tax-optimization strategy that takes advantage of different types of investments, getting different tax treatments. Investors who own a variety of taxable, tax-deferred, and tax-exempt accounts can benefit from asset location. By doing Roth conversion, you can determine which securities should be held in tax-deferred accounts and which in Roth accounts to maximize your after-tax returns.

No Required Minimum Distributions

Traditional IRA rules mandate you to take taxable required minimum distributions (RMDs) every year after you reach age 72.

Alternatively, your Roth IRA does not require minimum distributions at any age. Your money can stay in the account and grow tax-free for as long as you want them.

Leave behind a tax-free legacy

The Roth IRA can play a crucial role in your estate planning. Your heirs who inherit your Roth IRA will receive a tax-free gift. They will be required to take distributions from the account. However, they will not have to pay any income tax on the withdrawals if the Roth IRA has been open for at least five years. Roth IRA is especially appealing if your heirs are in a higher tax bracket than you.

Keep Social Security income tax and Medicare Premiums low

Another hidden benefit of the Roth conversion is it could potentially lower your future social security income tax and Medicare Premiums.

Up to 85% of your Social Security checks can be taxable for individuals earning more than $34,000 and families receiving more than $44,000 per year.

Your Medicare Plan B premium will be calculated based on your reported income-related monthly adjustment amount (IRMAA) 2 years prior to your application. Even a dollar higher can push in a higher premium bracket,

Roth Conversion Strategies

With some planning, Roth IRA offers substantial tax-free benefits. Due to income limits, many retirement savers end up with significant amounts in tax-deferred accounts such as 401k and Traditional IRA. These plans give you initial tax relief to encourage retirement savings. However, all future distributions are fully taxable.

The Roth conversion may help you reduce your future tax burden and unlock some of the befits of Roth IRA. Here are some of the strategies that can be helpful in your decision process.

  

End-of-year Roth conversion

The stability of your income can be critical to your success. Each conversion must be completed by the end of each tax year. If your income is constant, you can process the conversion at any time. If your income is less predictable, your only choice will be to make your conversions towards the end of the year when you will have more visibility on your earnings.

Conversion during low-income years

The Roth conversion is generally more attractive during your low-income years when you will be in a lower tax bracket. The additional reported income from the conversion will add on to your base earnings. If you do the math right, you will be able to maintain your taxes relatively low. Analyze your tax bracket and convert the amount that will keep in your desired marginal tax rate.

Conversion during a market downturn

Another popular strategy is performing Roth conversion during a market downturn. A Roth conversion could become appealing if your Traditional IRA is down 20% or 30%. At the same time, you have a long-term investment horizon and believe that your portfolio will recover the losses over time.

Your largest benefit will come from the potential tax-free portfolio gains after the stock market goes higher. With this approach, your underlying taxes take a lower priority versus the ability to earn higher tax-free income in the future. However, you still need to determine whether saving taxes on future gains provides a higher benefit than paying higher taxes now.

Monthly or quarterly cost averaging

Timing the stock market is hard. The cost averaging strategy removes the headache of trying to figure out when the stock market will go up or down. This approach calls for making planned periodic, monthly, or quarterly, conversions. The benefit of this method is that at least part of your portfolio may benefit from lower stock values. It is a way to hedge your bets on surprising stock market moves. If your portfolio goes higher consistently throughout the year, your earlier conversions will benefit from lower stock values. If the stock market goes down in the second half of the year, your later-in-the-year conversion will produce a higher benefit.

Roth Conversion barbelling

This strategy makes sense if your annual income is variable and less predictable. For example, your income fluctuates due to adjustments in commissions, bonuses, royalties, or other payments. With barbelling, you perform two conversions per year. You make the first conversion early in the year based on a projected income that is at the high end of the range. The second conversion will occur towards the end of the year, when your income becomes more predictable. If your income is high, you may convert a much smaller amount or even nothing. If your earnings for the year are at the lower end of expectation, then you convert a larger amount.

Roth Conversion Ladder

As I mentioned earlier, each Roth conversion is subject to its own 5-year rule. The 5-year period starts on January 1st of the tax year of your Roth conversion. Every subsequent conversion will have a separate 5-year holding period.

The Roth Conversion ladder strategy requires a bit of initial planning. This approach stipulates that you make consistent annual conversions year after year. After every five years, you can withdraw your savings tax-free from the Roth IRA. In effect, you are creating a ladder similar to the CD ladder.

Keep in mind that this strategy only makes sense under two conditions. One, you can afford to pay taxes for the conversion from another taxable account. Second, your future taxable income is expected to increase, and therefore you would be in a higher tax bracket.

Conclusion

Roth Conversion can be a great way to manage your future taxes. However, not every person or every family is an ideal candidate for a Roth conversion. In reality, most people tend to have lower reportable income when they retire. For them keeping your Traditional IRA and taking distributions at a lower tax rate makes a lot of sense. However, there are a lot of financial, personal, and legacy planning factors that come into play. Make your decision carefully. Take a comprehensive look at your finance before you decide if Roth conversion is right for you.

Tax Saving Ideas for 2021

Tax Saving ideas for 2021

As we approach the end of  2021, I am sharing my favorite list of tax-saving ideas that can help you lower your tax bill for 2021. In my practice, In the US tax rules change frequently. 2021 was no exception.

I believe that proactive tax planning is essential for achieving your financial goals. Furthermore, it is key to achieving tax alpha.  For you,  achieving Tax Alpha is a process that starts on day 1.  Making smart tax decisions can help you grow your wealth while you prepared for various outcomes. 

Today, you have a great opportunity to review your finances. You can make several smart and easy tax moves that can lower your tax bill and increase your tax refund. Being ahead of the curve will help you make well-informed decisions without the stress of tax deadlines. Start the conversation today. 

Retirement Calculator

1. Know your tax bracket

The first step of managing your taxes is knowing your tax bracket. In 2021, federal tax rates fall into the following brackets depending upon your taxable income and filing status. Knowing where you land on the tax scale can help you make informed decisions especially when you plan to earn additional income, exercise stock options, or receive RSUs

Here are the Federal tax bracket and rates for 2021.

Tax Rate Taxable Income Taxable Income
  (Single) (Married Filing Jointly)
10% Up to $9,950 Up to $19,900
12% $9,951 to $40,525 $19,901 to $81,050
22% $40,526 to $86,375 $81,051 to $172,750
24% $86,376 to $164,925 $172,751 to $329,850
32% $164,926 to $209,425 $329,851 to $418,850
35% $209,426 to $523,600 $418,851 to $628,300
37% $523,601 or more $628,301 or more

2. Decide to itemize or use a standard deduction

The standard deduction is a specific dollar amount that allows you to reduce your taxable income. Nearly 90% of all tax filers use the standard deduction instead of itemizing. It makes the process a lot simpler for many Americans. However, in some circumstances, your itemized deductions may surpass the dollar amount of the standard deduction and allow you to lower your tax bill even further.

Here are the values for 2021:

Filing status 2021 tax year
Single $12,550
Married, filing jointly $25,100
Married, filing separately $12,550
Head of household $18,800

3. Maximize your retirement contributions

You can save taxes by contributing to a retirement plan. 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 2021 is $19,500. If you are at the age of 50 or older, you can contribute an additional $6,500.
  • For business owners – SEP IRA, Solo 401k, and Defined Benefit Plan. Business owners can contribute to SEP IRA, Solo 401k, and Defined Benefit Plans to maximize your retirement savings and lower your tax bill. The maximum contribution to SEP-IRA and Solo 401k in 2021 is $58,000 or $64,500 if you are 50 and older.

If you own SEP IRA, you can contribute up to 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 $19,500 limit plus a $6,500 catch-up. The employer match is limited to 25% of your compensation for a maximum of $38,500. In many cases, the solo 401k plan can allow you to save more than SEP IRA.

A defined Benefit Plan 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

Transferring investments 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.

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

If you believe that your taxes will go up in the future, Roth Conversion could be a very effective way to manage your future taxes. 

5. Contribute to a 529 plan

The 529 plan is a tax-advantaged state-sponsored investment plan, allowing 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 significantly lower your state tax bill.

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. Your contributions can be in cash, household good, appreciated assets, or directly from your IRA distributions. 

Charitable donations are tax-deductible only when you itemize your tax return. If you make small contributions throughout the year, you might be better off taking the standard deduction instead.

If itemizing your taxes is crucial for you, 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. Tax-loss harvesting

The stock market can be volatile. If you are holding stocks and other investments that dropped significantly in 2021, you can consider selling them. 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 (401k, Traditional IRA, and Roth IRA). Capital assets may include real estate, cryptocurrency, 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. Furthermore, you can carry forward your capital losses for future years and offset future gains.

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 2021:

Long-term capital gains tax rate Single Married Filing Jointly
0% $0 to $40,400 $0 to $80,800
15% $40,401 – $445,850 $80,801 to $501,600
20% Over $445,850 Over $501,601

Furthermore, high-income earners will also pay an additional 3.8% net investment income tax.

9. Contribute to FSA

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

Flexible Spending Account (FSA)

A Flexible Spending Account (FSA) is 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 2021 is $2,750 per person. If you are married, your spouse can save another $2,750 for a total of $5,500 per family.  Some employers offer a matching FSA contribution for up to $500. Typically,  you must use your FSA savings by the end of the calendar year. However, for 2021, The American Rescue Plan Act (ARPA) allowed you to carry over your entire balance into the new year.

Dependent Care FSA (DC-FSA)

A Dependent Care FSA  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 American Rescue Plan Act (ARPA) raised pretax contribution limits for dependent care flexible spending accounts (DC-FSAs) for the calendar year 2021.   For married couples filing jointly or single parents filing as head of household, the maximum contribution limit is $10,500. 

10. Child and dependent care tax credit

The enhanced credit for 2021 allows eligible parents to claim up to 50% of  $8,000 per child in dependent care expenses for a maximum of two children.  The maximum credit will be 50% of $16,000.  Keep in mind that you cannot use your DC-FSA funds to claim this credit

The credit percentage gradually phases down to 20 percent for individuals with incomes between $125,000 and $400,000, and further phases down by 1 percentage point for each $2,000 (or fraction thereof) by which an individual’s adjusted gross income exceeds $400,000,

11.. Contribute to 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.

Keep in mind that the HSA has three distinct tax advantages.

  1. All HSA contributions are tax-deductible and will lower your tax bill.
  2. Your investments grow tax-free. You will not pay taxes on dividends, interest, and capital gains.
  3. If you use the account for eligible medical expenses, you don’t pay taxes on those withdrawals.

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 $1,400 for an individual and $2,800 for a family. Additionally, your HDHP must have an out-of-pocket maximum of up to $7,000 for one-person coverage or $14,000 for family.

The maximum contributions in HSA for 2021 are $3,600 for individual coverage and $7,200 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.

12. Defer or accelerate income

Is 2021 shaping to be a high income for you? Perhaps, you can defer some of your income from this calendar year into 2021 and beyond. This move 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 one-time payment. Remember, it only makes sense to defer income if you expect to be in a lower tax bracket next year.

On the other hand, if you expect to be in a higher tax bracket tax year next year, you may consider taking as much income as possible in 2021.

Successful strategies for (NOT) timing the stock market

Timing the stock market

Timing the stock market is an enticing idea for many investors.  However, even experienced investment professionals find it nearly impossible to predict the daily market swings, instant sector rotations, and ever-changing investors’ sentiments. The notion that you can perfectly sell at the top of the market and buy at the bottom is naïve and oftentimes leads to bad decisions.

The 24-hour news cycle is constantly bombarding us. The speed and scale of information could easily bounce the stock market between desperation, apathy, and fear to euphoria, FOMO, and irrational exuberance.

In that sense, the market volatility can be unnerving and depressing. However, for long-term investors, trying to time the market tops and bottoms is a fool’s errand. Constantly making an effort to figure out when to get in and get out can fire back. There is tremendous evidence that most investors reduce their long-term returns trying to time the market. Market timers are more likely to chase the market up and down and get whipsawed, buying high and selling low.

The hidden cost of timing the stock market

There is a hidden cost in market timing.  According to Fidelity, just missing 5 of the best trading days in the past 40 years could lower your total return by 38%. Missing the best 10 days will cut your return in half.

Source: Fidelity
Source: Fidelity

For further discussion on how to manage your portfolio during times of extreme market volatility, check my article on “Understanding Tail Risk

Rapid trading

Today’s stock market is dominated by algorithm trading platforms and swing traders with extremely short investment horizons.  Most computerized trading strategies hold their shares for a few seconds, not even minutes. Many of these strategies are run by large hedge funds. They trade based on market signals, momentum, and various inputs built within their models. They can process information in nanoseconds and make rapid trades. The average long-term investors cannot and should not attempt to outsmart these computer models daily.

Reuters calculated that the average holding period for U.S. shares was 5-1/2 months as of June 2020, versus 8-1/2 months at the of end-2019. In 1999, for example, the average holding period was 14 months. In the 1960s and 1970, the investors kept their shares for 6 to 8 years.

Timing the stock market
Timing the stock market

 

The market timing strategy gives those investors a sense of control and empowerment, It doesn’t necessarily mean that they are making the right decisions.

So, if market turmoil gives you a hard time, here are some strategies that can help you through volatile times.

Dollar-cost average

DCA is the proven approach always to be able to time the market.  With DCA, you make constant periodic investments in the stock market. And you continue to make these investments whether the market is up or down. The best example of DCA is your 401k plan. Your payroll contributions automatically invest every two weeks.

Diversify

Diversification is the only free lunch in investing. Diversification allows you to invest in a broad range of asset classes with a lower correlation between them.  The biggest benefit is lowering the risk of your investment portfolio, reducing volatility, and achieving better risk-adjusted returns.  A well-diversified portfolio will allow your investments to grow at various stages of the economic cycle as the performance of the assets moves in different directions.

Rebalance

Rebalancing is the process of trimming your winners and reinvesting in other asset classes that haven’t performed as successfully.  Naturally, one may ask, why should I sell my winners? The quick answer is diversification. You don’t want your portfolio to become too heavy in a specific stock, mutual fund, or ETF. By limiting your exposure, you will allow yourself to realize gains and buy other securities with a different risk profile.

Buy and hold

For most folks, Buy and Hold is probably the best long-term strategy. As you saw earlier,  there is a huge hidden cost of missing out on the best trading days in a given period. So being patient and resilient to noise and negative news will ultimately boost your wealth. You have to be in it to win it.

Tax-loss harvesting

If you are holding stocks in your portfolio, the tax-loss harvesting allows you to take advantage of price dips and lower your taxes. This strategy works by selling your losers at a loss and using the proceeds to buy similar security with an identical risk-reward profile. At the time of this article, you can use capital losses to offset any capital gains from the sale of profitable investments. Furthermore,  you can use up to $3,000 of residual capital loss to offset your regular income. The unused amount of capital loss can be carried forward in the next calendar year and beyond until it’s fully used.

Maintain a cash reserve

I advise all my clients to maintain an emergency fund sufficient to cover at least 6 months worth of expenses. An emergency fund is especially critical If you are relying on your investment portfolio for income. The money in your emergency fund will help you withstand any unexpected market turbulence and decline in your portfolio balance. A great example would be the rapid market correction in March 2020 at the onset of the coronavirus outbreak. If you needed to sell stocks from your portfolio, you would be in tough luck. But if you had enough cash to keep afloat through the crisis, you would have been in a perfect position to enjoy the next market rebound.

Focus on your long term goals

My best advice to my clients who get nervous about the stock market is to focus on what they can control.  Define your long-term goals and make a plan on how to achieve them. The stock market volatility can be a setback but also a huge opportunity for you. Follow your plan no matter what happens on the stock market. Step back from the noise and focus on strengthening your financial life.

Tax Saving Moves for 2020

Tax Saving Moves for 2020

As we approach the end year, we share our list of tax-saving moves for 2020. 2020 has been a challenging and eventful year. The global coronavirus outbreak changed the course of modern history. The Pandemic affected many families and small businesses. The stock market crashed in March, and It had a full recovery in just a few months.

With so many changes, now is a great time to review your finances. You can make a few smart and simple tax moves that can lower your tax bill and increase your tax refund.

Whether you file taxes yourself or hire a CPA, it is always better to be proactive. If you expect a large tax bill or your financials have changed substantially, talk to your CPA. Start the conversation today. 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. 2020 is the third 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 2020.

Tax Brackets 2020

2. Decide to itemize or use a standard deduction

Another recent 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 2020:

Filing status 2020 tax year
Single $12,400
Married, filing jointly $24,800
Married, filing separately $12,400
Head of household $18,650

3. Maximize your retirement contributions

You can save taxes by contributing to a retirement plan. 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 2020 is $19,500. If you are at the age of 50 or older, you can contribute an additional $6,500.
  • For business owners – SEP IRA, Solo 401k, and Defined Benefit Plan. Business owners can contribute to SEP IRA, Solo 401k, and Defined Benefit Plans to maximize your retirement savings and lower your tax bill. The maximum contribution to SEP-IRA and Solo 401k in 2020 is $57,000 or $63,500 if you are 50 and older.

If you own SEP IRA, you can contribute up to 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 $19,500 limit plus a $6,500 catch-up. The employer match is limited to 25% of your compensation for a maximum of $37,500. In many cases, the solo 401k plan can allow you to save more 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

Transferring investments 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.

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

If you believe that your taxes will go up in the future, Roth Conversion could be a very effective way to manage your future taxes. 

5. Contribute to a 529 plan

The 529 plan is a tax-advantaged state-sponsored investment plan, allowing 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 significantly lower your state tax bill.

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

If itemizing your taxes is crucial for you, 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

2020 has been turbulent for the stock market. If you are holding stocks and other investments that dropped significantly in 2020, you can consider selling them. 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 (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 2020:

Long-Term Capital Gains Tax Rate Single Filers (Taxable Income) Married Filing Separately
0% $0-$40,000 $0-$40,000
15% $40,000-$441,450 $40,000-$248,300
20% Over $441,550 Over $248,300

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

9. Contribute to 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 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 2020 is $2,750 per person. If you are married, your spouse can save another $2,750 for a total of $5,500 per family.  Some employers offer a matching FSA contribution for up to $500. Typically, it would help if you used 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 2020 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 $1,400 for an individual and $2,800 for a family. Additionally, your HDHP must have an out-of-pocket maximum of up to $6,900 for one-person coverage or $13,800 for family.

The maximum contributions in HSA for 2020 are $3,550 for individual coverage and $7,100 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.

10. Defer income

Is 2020 shaping to be a high income for you? Perhaps, you can defer some of your income from this calendar year into 2021 and beyond. This move 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 one-time payment. Remember, it only makes sense to defer income if you expect to be in a lower tax bracket next year.

On the other hand, if you expect to be in a higher tax bracket tax year next year, you may consider taking as much income as possible in 2020.

11. Skip RMDs

Are you taking the required minimum distributions (RMD) from your IRA or 401k plan? The CARES Act allows retirees to skip their RMD in 2020. If you don’t need the extra income, you can skip your annual distribution. This move will lower your taxes for 2020 and may cut your future Medicare cost.

12. Receive employee retention tax credit for eligible businesses

The CARES Act granted employee retention credits for eligible businesses affected by the Coronavirus pandemic. The credit amount equals 50% of eligible employee wages paid by an eligible employer in a 2020 calendar quarter. The credit is subject to an overall wage cap of $10,000 per eligible employee.

Qualifying businesses must fall into one of two categories:

  • The employer’s business is fully or partially suspended by government order due to COVID-19 during the calendar quarter.
  • The employer’s gross receipts were below 50% of the comparable quarter in 2019. Once the employer’s gross receipts went above 80% of a comparable quarter in 2019, they no longer qualify after the end of that quarter.

 

15 Costly retirement mistakes

15 Costly retirement mistakes

15 Costly retirement mistakes… Retirement is a major milestone for many Americans. Retiring marks the end of your working life and the beginning of a new chapter. As a financial advisor, my job is to help my clients avoid mistakes and retire with confidence and peace of mind.  Together we build a solid roadmap to retirement and a gameplan to achieve your financial goals. My role as a financial advisor is to provide an objective and comprehensive view of my clients’ finances.  As part of my process, I look for any blind spots that can put my clients’ plans at risk.  Here is a list of the major retirement mistakes and how to avoid them.

1. Not planning ahead for retirement

Not planning ahead for retirement can cost you a lot in the long run. Delaying to make key decisions is a huge retirement mistake that can jeopardize your financial security during retirement. Comprehensive financial planners are more likely to save for retirement and feel more confident about achieving their financial goals.  Studies have shown that only 32% of non-planners are likely to have enough saved for retirement versus 91% of comprehensive planners.

Reviewing your retirement plan periodically will help you address any warning signs in your retirement plan. Recent life changes, economic and market downturns or change in the tax law could all have a material impact on your retirement plans. Be proactive and will never get caught off guard.

2. Not asking the right questions

Another big retirement mistake is the fear of asking the right question. Avoiding these

Here are some of the questions that my clients are asking –

  • “Do I have enough savings to retire?”
  •  “Am I on the right track?”.
  • “Can I achieve my financial goals?”
  • “Can I retire if the stock market crashes?”.
  • “Are you fiduciary advisor working in my best interest?” (Yes, I am fiduciary)

Asking those tough questions will prepare you for a successful retirement journey. Addressing your concerns proactively will take you on the right track of meeting your priorities and achieving your personal goals

3. Not paying off debt

Paying off debt can be an enormous burden during retirement. High-interest rate loans can put a heavy toll on your finances and financial freedom. As your wages get replaced by pension and social security benefits, your expenses will remain the same. If you are still paying off loans, come up with a plan on how to lower your debt and interest cost. Being debt-free will reduce the stress out of losing viable income.

4. Not setting goals

Having goals is a way to visualize your ideal future. Not having goals is a retirement mistake that can jeopardize your financial independence during retirement. Without specific goals, your retirement planning could be much harder and painful. With specific goals, you have clarity of what you want and what you want to achieve. You can make financial decisions and choose investment products and services that align with your objectives and priorities. Setting goals will put you on a successful track to enjoy what matters most to you.

5. Not saving enough

An alarming 22% of Americans have less than $5,000 in retirement savings. The average 401k balance according to Fidelity is $103,700. These figures are scary. It means that most Americans are not financially ready for retirement. With ultra-low interest rates combined with constantly rising costs of health care,  future retirees will find it difficult to replace their working-age income once they retire. Fortunately, many employers now offer some type of workplace retirement savings plans such as 401k, 403b, 457, TSP or SEP IRA. If your employer doesn’t offer any of those, you can still save in Traditional IRA, Roth IRA, investment account or the old fashioned savings account.

6. Relying on one source for retirement income

Many future retirees are entirely dependent on a single source for their retirement income such as social security or pension.  Unfortunately. with social security running out of money and many pension plans shutting down or running a huge deficit, the burden will be on ourselves to provide reliable income during our retirement years.  If you want to be financially independent, make sure that your retirement income comes from multiple sources.

7. Lack of diversification

Diversification is the only free lunch you can get in investing and will help decrease the overall risk of your portfolio. Adding uncorrelated asset classes such as small-cap, international and emerging market stocks, bonds, and commodities will reduce the volatility of your investments without sacrificing much of the expected return in the long run.

A common mistake among retirees is the lack of diversification. Many of their investment portfolios are heavily invested in stocks, a target retirement fund or a single index fund.

Furthermore, owning too much of one stock or a fund can cause significant issues to your retirement savings. Just ask the folks who worked for Enron or Lehman Brothers who had their employer’s stocks in their retirement plans. Their lifetime savings were wiped out overnight when these companies filed for bankruptcy.

8. Not rebalancing your investment portfolio

Regular rebalancing ensures that your portfolio stays within your desired risk level. While tempting to keep a stock or an asset class that has been on the rise, not rebalancing to your original target allocation can significantly increase the risk of your investments.

9. Paying high fees

Paying high fees for mutual funds and high commission insurance products can eat up a lot of your return. It is crucial to invest in low-cost investment managers that can produce superior returns over time. If you own a fund that has consistently underperformed its benchmark,  maybe it’s time to revisit your options.

Many insurance products like annuities and life insurance while good on paper, come with high upfront commissions, high annual fees, and surrender charges and restrictions.  Before signing a contract or buying a product, make sure you are comfortable with what you are going to pay.

10. No budgeting

Adhering to a budget before and during retirement is critical for your confidence and financial success. When balancing your budget, you can live within your means and make well-informed and timed decisions. Having a budget will ensure that you can reach your financial goals.

11. No tax planning

Not planning your taxes can be a costly retirement mistake. Your pension and social security are taxable. So are your distributions from 401k and IRAs. Long-term investing will produce gains, and many of these gains will be taxable. As you grow our retirement saving the complexity of assets will increase. And therefore the tax impact of using your investment portfolio for retirement income can be substantial. Building a long-term strategy with a focus on taxes can optimize your after-tax returns when you manage your investments.

12. No estate planning

Many people want to leave some legacy behind them. Building a robust estate plan will make that happen. Whether you want to leave something to your children or grandchildren or make a large contribution to your favorite foundation, estate, and financial planning is important to secure your best interests and maximize the benefits for yourself and your beneficiaries.

13. Not having an exit planning

Sound exit planning is crucial for business owners. Often times entrepreneurs rely on selling their business to fund their retirement. Unlike liquid investments in stocks and bonds, corporations and real estate are a lot harder to divest.  Seling your business may have serious tax and legal consequences. Having a solid exit plan will ensure the smooth transition of ownership, business continuity, and optimized tax impact.

14. Not seeing the big picture

Between our family life, friends, personal interests, causes, job, real estate properties, retirement portfolio, insurance and so on, our lives become a web of interconnected relationships. Above all is you as the primary driver of your fortune. Any change of this structure can positively or adversely impact the other pieces. Putting all elements together and building a comprehensive picture of your financial life will help you manage these relationships in the best possible way.

15. Not getting help

Some people are very self-driven and do very well by planning for their own retirement. Others who are occupied with their career or family may not have the time or ability to deal with the complexities of financial planning. Seeking help from a fiduciary financial planner can help you avoid retirement mistakes. A fiduciary advisor will watch for your blind spots and help you find clarity when making crucial financial decisions.

How to Survive the next Market Downturn

How to survive a market downturn

Everything you need to know about surviving the next market downturn: we are in the longest bull market in US history. After more than a decade of record-high stock returns, many investors are wondering if there is another market downturn on the horizon. With so many people saving for retirement in 401k plans and various retirement accounts, it’s normal if you are nervous. But if you are a long-term investor, you know these market downturns are inevitable. Market downturns are stressful but a regular feature of the economic cycle.

What is the market downturn?

A market downturn is also known as a bear market or a market correction. During a market downturn, the stock market will experience a sharp decline in value. Often, market downturns are caused by fears of recession, political uncertainty, or bad macroeconomic data.

How low can the market go down?

The largest-ever percentage drop by the S&P 500 index occurred on October 19, 1987 (known as The Black Monday), when the S&P 500 dropped by -20.47%. The next biggest selloff happened on October 15, 2008, when the S&P 500 lost –9.03%. In both cases, the stock market continued to be volatile for several months before reaching a bottom. Every time, the end of the market downturn was the start of a new bull market. Both times, the stock market recovered and reached historic highs in a few years.

What can you do when the next market downturn happens?

The first instinct you may have when the market drops is to sell your investments. In reality, this may not always be the right move. Selling your stocks during market selloff may limit your losses, may lock in your gains but also may lead to missed long-term opportunities. Emotional decisions do not bring a rational outcome.

Dealing with declining stock values and market volatility can be tough. The truth is nobody likes to lose money. The volatile markets can be treacherous for seasoned and inexperienced investors alike. To be a successful investor, you must remain focused on the strength of your portfolio, your goals, and the potential for future growth. I want to share nine strategies that can help you through the next market downturn and boost the long-term growth of your portfolio.

1. Keep calm during the market downturn

Stock investors are cheerful when the stock prices are rising but get anxious during market corrections. Significant drops in stock value can trigger panic. However, fear-based selling to limit losses is the wrong move. Here’s why. Frequently the market selloffs are followed by broad market rallies. A V-shape recovery often follows a market correction.

The hypothetical table below looks at the performance of $10,000 invested in the S&P 500 between January 4, 1988, and December 31, 2018. It’s important to note this hypothetical investment occurred during two of the biggest bear markets in history, the 2000 tech bubble crash and the 2008 global financial crisis. If you had missed the ten best market days, you would lose 2.4% of your average annual return and nearly half of your dollar return.

As long as you are making sound investment choices, your patience and the ability to tolerate paper losses will earn you more in the long run.

2. Be realistic: Don’t try to time the market

Many investors believe that they can time the market to buy low and sell high. In reality, very few investors succeed in these efforts.

According to a study by the CFA Institute Financial Analyst Journal, a buy-and-hold large-cap strategy would have outperformed, on average, about 80.7% of annual active timing strategies when the choice was between large-cap stocks, short-term T-bills, and Treasury bonds.

3. Stay diversified

Diversification is essential for your portfolio preservation and growth. Diversification, or spreading your investments among different asset classes (domestic versus foreign stocks, large-cap versus small-cap equity, treasury and corporate bonds, real estate, commodities, precious metals, etc.), will lower the risk of your portfolio in the long-run. Many experts believe that diversification is the only free lunch you can get in investing.

Uncorrelated asset classes react uniquely during market downturns and changing economic cycles.

For example, fixed income securities and gold tend to rise during bear markets when stocks fall. Conversely, equities rise during economic expansion.

4. Rebalance your portfolio regularly

Rebalancing your portfolio is a technique that allows your investment portfolio to stay aligned with your long terms goals while maintaining a desired level of risk. Typically, portfolio managers will sell out an asset class that has overperformed over the years and is now overweight. With the proceeds of the sale, they will buy an underweighted asset class.

Hypothetically, if you started investing in 2010 with a portfolio consisting of 60% Equities and 40% Fixed Income securities, without rebalancing by the end of 2019, you will hold 79% equities and 21% fixed income. Due to the last decade’s substantial rise in the stock market, many conservative and moderate investors are now holding significant equity positions in their portfolio. Rebalancing before a market downturn will help you bring your investments to your original target risk levels. If you reduce the size of your equity holdings, you will lower your exposure to stock market volatility.

5. Focus on your long-term goals

A market downturn can be tense for all investors. Regardless of how volatile the next stock market correction is, remember that “this too shall pass.”

Market crises come and go, but your goals will most likely remain the same. In fact, most goals have nothing to do with the market. Your investment portfolio is just one of the ways to achieve your goals.

Your personal financial goals can stretch over several years and decades. For investors in their 20s and 30s financial goals can go beyond 30 – 40 years. Even retirees in their 60s must ensure that their money and investments last through several decades.

Remain focused on your long-term goals. Pay of your debt. Stick to a budget. Maintain a high credit score. Live within your means and don’t risk more than you can afford to lose.

6. Use tax-loss harvesting during the market downturn

If you invest in taxable accounts, you can take advantage of tax-loss harvesting opportunities. You can sell securities at depressed prices to offset other capital gains made in the same year. Also, you can carry up to $3,000 of capital losses to offset other income from salary and dividends. The remaining unused amount of capital loss can also be carried over for future years for up to the allowed annual limit.

To take advantage of this option, you have to follow the wash sale rule. You cannot purchase the same security in the next 30 days. To stay invested in the market, you can substitute the depressed stock with another stock that has a similar profile or buy an ETF.

7. Roth Conversion

A falling stock market creates an excellent opportunity to do Roth Conversion. Roth conversion is the process of transferring Tax-Deferred Retirement Funds from a Traditional IRA or 401k plan to a tax-exempt Roth IRA. The Roth conversion requires paying upfront taxes with a goal to lower your future tax burden. The depressed stock prices during a market downturn will allow you to transfer your investments while paying lower taxes. For more about the benefits of Roth IRA, you can read here.

8. Keep a cash buffer

I always recommend to my clients and blog readers to keep at least six months of essential living expenses in a checking or a savings account. We call it an emergency fund. It’s a rainy day, which you need to keep aside for emergencies and unexpected life events. Sometimes market downturns are accompanied by recessions and layoffs. If you lose your job, you will have enough reserves to cover your essential expenses. You will avoid dipping in your retirement savings.

9. Be opportunistic and invest

Market downturns create opportunities for buying stocks at discounted prices. One of the most famous quotes by Warren Buffet is “When it’s raining gold, reach for a bucket, not a thimble.” Market selloffs rarely reflect the real long-term value of a company as they are triggered by panic, negative news, or geopolitical events. For long-term investors, market downturns present an excellent opportunity to buy their favorite stocks at a low price. If you want to get in the market after a selloff, look for established companies with strong secular revenue growth, experienced management, solid balance sheet and proven track record of paying dividends or returning money to shareholders.

Final words

Market downturns can put a huge toll on your investments and retirement savings. The lack of reliable information and the instant spread of negative news can influence your judgment and force you to make rash decisions. Market selloffs can challenge even the most experienced investors. That said, don’t allow yourself to panic even if it seems like the world is falling apart. Prepare for the next market downturn by following my list of nine recommendations. This checklist will help you “survive” the next bear market while you still follow your long-term financial goals.