Harry Sit's Blog, page 28

529 Plan For High School Seniors and Students Already in College

[Updated on December 15, 2020 with the latest rates.]

Selecting investments to match your time horizon is arguably the #1 rule in investing. If you have a long time horizon, you can invest more in risky investments with a better long-term expected return. If you only have a short time horizon, you can only afford to invest in more stable instruments with a lower expected return.

529 plans for college expenses present such a classic case. As each year passes, your investment time horizon shrinks. When the child gets to the senior year in high school, your investment time horizon becomes really short. You know you will need 1/4 of the money in one year, and another 1/4 in two years, three years, and four years. However, Vanguard gives this asset allocation for students age 17-18 in the 529 plan it manages:

21% in stocks52% in bonds27% in short-term reserves

With 21% in stocks and over half in intermediate-term bonds, some investors may think this is too aggressive for money that will be needed soon. When you need 1/4 of your money in one year, another 1/4 in two years, another 1/4 in three years, and the final 1/4 in four years, on average your money is only invested for 2-1/2 years. Some investors prefer to invest money that will be needed in such a short time frame in principal-guaranteed options.

Many 529 plans offer a money market fund option. You can choose the money market fund for the stable principal but sitting in the money market for up to four years feels a bit of a waste. Is there something in between, something that gives you slightly better returns than the money market but has less risk than bond funds?

Only some 529 plans offer CDs and stable value funds. They strike that happy medium between risks and returns for students who are close to going to college or who are already in college.

FDIC-Insured CDs

Ohio’s ColleageAdvantage Direct 529 Plan offers FDIC-insured savings accounts and CDs. As of December 2020, the yields are 0.3% for 1-year to 4-year CDs. The yields are slightly better than the prevailing money market fund yields.

Stable Value Funds

A Stable Value Fund is like a bond portfolio with an insurance contract. It’s guaranteed by the insurance company, not by the government. A stable value fund can offer both a stable principal and a higher yield than a money market fund. However, unlike CDs, their yield isn’t guaranteed for a fixed term. It’s subject to periodic adjustments.

Washington DC’s DC College Savings Plan offers a Principal Protected Portfolio backed by Ameritas Life Insurance Corp. The crediting rate is 2.3% in the fourth quarter of 2020.

Colorado’s CollegeInvest Stable Value Plus plan is backed by Nationwide. The rate for the full year 2021 is 2.09% net after fees.

Utah’s My529 Plan offers PIMCO Interest Income Fund as a choice under its Customized Static option. The yield shown on the fact sheet was 2.41% as of September 30, 2020. The PIMCO fund has the advantage of investing in contracts from multiple financial institutions.

All three plans above are a good option. By comparison, the 30-day SEC yield on the Vanguard Total Bond Market Index Fund was 1.14% as of December 4, 2020.

Moving 529 Plans

Although 529 plans are offered by each state, you are not necessarily limited to using only your own state’s plan. If you like the CDs and stable value fund options offered by one of the plans mentioned above, it’s possible to move your 529 plan account to those plans when your child gets close to going to college.

State tax benefits vary. Based on my own research, if you live in the states colored green and orange below, moving a 529 plan account does not have a negative impact (in Oklahoma and Washington DC, only after satisfying a minimum stay requirement).

In the other states, you’d be better off staying with the state’s own 529 plan. See Using a 529 Plan From Another State Or Your Home State?

Before you choose a 529 plan from another state or move your 529 plan account, find out:

whether your state offers tax benefits on 529 plan contributions;whether it limits the tax benefits to a plan sponsored by itself; and whether it claws back the benefits you previously received if you move the money out to a plan from another state.

The map here is based on my own research to the best I can. It may not be 100% accurate. State laws can and do change. Please always double-check with your state’s tax authorities.

If you decide to move a 529 plan account, the logistics are quite simple, although you are limited to only one move in every rolling 12 months. See Rollover a 529 Account From One Plan To Another.

The post 529 Plan For High School Seniors and Students Already in College appeared first on The Finance Buff.

529 Plan For High School Seniors and College Students

[Updated on December 15, 2020 with the latest rates.]

Selecting investments to match your time horizon is arguably the #1 rule in investing. If you have a long time horizon, you can invest more in risky investments with a better long-term expected return. If you only have a short time horizon, you can only afford to invest in more stable instruments with a lower expected return.

529 plans for college expenses present such a classic case. As each year passes, your investment time horizon shrinks. When the child gets to the senior year in high school, your investment time horizon becomes really short. You know you will need 1/4 of the money in one year, and another 1/4 in two years, three years, and four years. However, Vanguard gives this asset allocation for students age 17-18 in the 529 plan it manages:

21% in stocks52% in bonds27% in short-term reserves

With 21% in stocks and over half in intermediate-term bonds, some investors may think this is too aggressive for money that will be needed soon. When you need 1/4 of your money in one year, another 1/4 in two years, another 1/4 in three years, and the final 1/4 in four years, on average your money is only invested for 2-1/2 years. Some investors prefer to invest money that will be needed in such a short time frame in principal-guaranteed options.

Many 529 plans offer a money market fund option. You can choose the money market fund for the stable principal but sitting in the money market for up to four years feels a bit of a waste. Is there something in between, something that gives you slightly better returns than the money market but has less risk than bond funds?

Only some 529 plans offer CDs and stable value funds. They strike that happy medium between risks and returns for students who are close to going to college or who are already in college.

FDIC-Insured CDs

Ohio’s ColleageAdvantage Direct 529 Plan offers FDIC-insured savings accounts and CDs. As of December 2020, the yields are 0.3% for 1-year to 4-year CDs. The yields are slightly better than the prevailing money market fund yields.

Stable Value Funds

A Stable Value Fund is like a bond portfolio with an insurance contract. It’s guaranteed by the insurance company, not by the government. A stable value fund can offer both a stable principal and a higher yield than a money market fund. However, unlike CDs, their yield isn’t guaranteed for a fixed term. It’s subject to periodic adjustments.

Washington DC’s DC College Savings Plan offers a Principal Protected Portfolio backed by Ameritas Life Insurance Corp. The crediting rate is 2.3% in the fourth quarter of 2020.

Colorado’s CollegeInvest Stable Value Plus plan is backed by Nationwide. The rate for the full year 2021 is 2.09% net after fees.

Utah’s My529 Plan offers PIMCO Interest Income Fund as a choice under its Customized Static option. The yield shown on the fact sheet was 2.41% as of September 30, 2020. The PIMCO fund has the advantage of investing in contracts from multiple financial institutions.

All three plans above are a good option. By comparison, the 30-day SEC yield on the Vanguard Total Bond Market Index Fund was 1.14% as of December 4, 2020.

Moving 529 Plans

Although 529 plans are offered by each state, you are not necessarily limited to using only your own state’s plan. If you like the CDs and stable value fund options offered by one of the plans mentioned above, it’s possible to move your 529 plan account to those plans when your child gets close to going to college.

State tax benefits vary. Based on my own research, if you live in the states colored green and orange below, moving a 529 plan account does not have a negative impact (in Oklahoma and Washington DC, only after satisfying a minimum stay requirement).

In the other states, you’d be better off staying with the state’s own 529 plan. See Using a 529 Plan From Another State Or Your Home State?

Before you choose a 529 plan from another state or move your 529 plan account, find out:

whether your state offers tax benefits on 529 plan contributions;whether it limits the tax benefits to a plan sponsored by itself; and whether it claws back the benefits you previously received if you move the money out to a plan from another state.

The map here is based on my own research to the best I can. It may not be 100% accurate. State laws can and do change. Please always double-check with your state’s tax authorities.

If you decide to move a 529 plan account, the logistics are quite simple, although you are limited to only one move in every rolling 12 months. See Rollover a 529 Account From One Plan To Another.

The post 529 Plan For High School Seniors and College Students appeared first on The Finance Buff.

Cap On Paying Back ACA Health Insurance Subsidy Premium Tax Credit

For the most part, the ACA health insurance subsidy, aka the premium tax credit, is set up such that it doesn’t matter how much you receive upfront when you enroll. The upfront subsidy is only an estimate. The final subsidy is squared up on your tax return. If you didn’t receive the subsidy when you enrolled but your actual income qualifies, you will get the subsidy as a tax credit when you file your tax return. If the government paid more subsidy than your actual income qualifies for, you will have to pay back the difference on your tax return.

If you aren’t short on cash, there are some advantages in estimating a high income during enrollment and not receiving the subsidy upfront. When you don’t ask for the subsidy, you don’t have to submit any document to prove your income. Your enrollment goes through very easily. You will earn credit card rewards when you pay the full premium to the insurance company. That’s worth much more than receiving the subsidy sooner. I always choose to pay in full and wait for any subsidy until I file my tax return. If I qualify for the subsidy, I’ll get it then. If I don’t qualify, nothing changes. See ACA Health Insurance: Ask For Premium Assistance Or Not.

However, in some cases you’re better off submitting income documentation and trying to qualify for the subsidy upfront.

Cost-Sharing Reductions

If your income is at 250% of the Federal Poverty Level (FPL) or below, you qualify for Cost-Sharing Reductions (CSR) in the form of a lower deductible, lower co-pays, and/or a lower out-of-pocket maximum on your health insurance. For example, a normal Silver plan in my area has a $4,500 deductible and an $8,500 out-of-pocket maximum. If your income is under 200% FPL, the Silver plan with the CSR has a $700 deductible and a $1,800 out-of-pocket maximum. That’s a big difference.

The CSR is only available on Silver plans, and you get into the better Silver plan only when you can justify upfront that your estimated annual income will be at 250% FPL or below. You won’t get your deductible or out-of-pocket maximum adjusted after the fact if you wait until you file your tax return. If your estimated income is at 250% FPL or below, don’t wait.

250% of FPL for a household of two people in the lower 48 states is about $43,000 in 2021. If your income isn’t that low, the CSR doesn’t apply to you.

Minimum Income Threshold

In addition to the maximum income to qualify for the premium tax credit, ACA also has a minimum income threshold. The minimum threshold is 100% of the Federal Poverty Level (FPL) in states that didn’t expand Medicaid and 138% of FPL in states that did. See Status of State Medicaid Expansion Decisions: Interactive Map from Kaiser Family Foundation.

100% FPL for a household of two people in the lower 48 states is $17,240 in 2021. 138% is $23,791. If there’s any chance that your income will fall below the minimum threshold, you should get your subsidy upfront at the time of enrollment. If you received the subsidy upfront and then your income unexpectedly falls below the minimum, you’ll still qualify for the premium tax credit on your tax return. If you didn’t receive the subsidy upfront, you won’t qualify for the premium tax credit on the tax return when your income is below the minimum threshold.

Repayment Cap

If you ask for the subsidy upfront, and your income ends up higher than your estimate, you’ll have to pay back some of the subsidy. There’s a cap on how much you need to pay back. The cap varies depending on your Modified Adjusted Gross Income (MAGI) and your tax filing status. It’s also adjusted for inflation each year. Here are the caps on paying back the subsidy for 2020 and 2021. The caps are the same in both years due to rounding.

MAGI2020 Coverage2021 Coverage< 200% FPLSingle: $325
Other: $650Single: $325
Other: $650 < 300% FPLSingle: $800
Other: $1,600Single: $800
Other: $1,600 < 400% FPLSingle: $1,350
Other: $2,700Single: $1,350
Other: $2,700 >= 400% FPLUnlimited Unlimited

Source: IRS Rev. Proc. 2019-44, Rev. Proc. 2020-45

The repayment cap applies only when your higher income still qualifies you for the premium tax credit. If your actual income exceeds the 400% of FPL cutoff and you don’t qualify for the subsidy anymore, there’s no repayment cap — you will have to pay back 100% of the advance subsidy you received.

The caps are also set sufficiently high such that unless there’s a big difference between your actual income and your estimated income at the time of enrollment, the amount you need to pay back will fall below the cap. For example, suppose you’re married filing jointly and you estimated your income would be $50,000 in 2021 when you enrolled. Suppose by the time you file your tax return, your income turns out to be $60,000. Because your income is $10,000 higher than you originally estimated, you qualify for a lower subsidy now. You will be required to pay back $1,133 as the difference. Because this difference is well under the $2,700 repayment cap, the cap doesn’t really help you.

In addition, because you’re required to notify the healthcare exchange of your income changes during the year in a timely manner so that they can adjust your advance subsidy, normally the difference in the advance subsidy you received and the subsidy you finally qualify for should be well under the cap. The cap helps only when your income increases close to the end of the year to make it too late to adjust your advance subsidy.

Still, a late income change can happen, and the change can be large enough to make the difference in the health insurance subsidy higher than the repayment cap. This is true especially when you’re single with a lower repayment cap. For example, suppose you’re single and you estimated your income would be $30,000 in 2021 when you enrolled. Suppose in December 2021 you decide to convert $20,000 in a Traditional IRA to a Roth IRA. This pushes your income to $50,000. The extra $20,000 income lowers your health insurance subsidy by $2,578, but because your repayment cap is $1,350, you only need to pay back $1,350. You get to keep the other $1,228. In this case, you’re better off asking for the subsidy upfront during enrollment. If you only wait until you file your tax return, you won’t benefit from the repayment cap.

Bottom line: in most cases the repayment cap doesn’t make any difference. However, if you think there’s a chance your income will increase a lot late in the year to make you benefit from the repayment cap, you should try to qualify for the subsidy upfront when you enroll. Maybe it’ll help. Maybe it won’t.

***

If you’re far from qualifying for the Cost-Sharing Reductions, falling below the minimum income threshold, or benefiting from the cap on repaying the subsidy, and your cash flow can afford the full premium upfront. you might as well save yourself some paperwork hassle and wait to claim your premium tax credit at tax time. That’s the case for me. I simply pay the full premium upfront, and I don’t worry about having to pay back any subsidy.

The post Cap On Paying Back ACA Health Insurance Subsidy Premium Tax Credit appeared first on The Finance Buff.

Pay Rent Electronically By Zelle: Daily Limit and Scheduling Payments

In many countries, bank account numbers work only one-way: if someone has your bank account number, they can put money into it but they can’t draw money out of it. Under this design, people who want to get paid happily give out their bank account numbers. Here in the U.S., bank account numbers work both ways: if someone has your bank account number, they can both put money into it (direct deposit) and draw money out of it (direct debit). This makes people uneasy in giving out their bank account information, even though the routing number and the account number are printed in plain view on their checks.

Because bank account numbers have no built-in protection for unauthorized debits, banks control who can access the system to do direct deposits and direct debits. Businesses can sign up for access, but in general, individuals can’t. This makes it difficult for individuals to pay another person electronically. Even if someone is willing to give me their bank routing number and account number, I can’t easily pay them with those numbers.

Some third-parties step in and act as a middleman to facilitate person-to-person payments. You pay the third-party and the third-party pays the other person. PayPal, Venmo, Cash App (Square), Apple Pay, Google Pay, and Facebook Pay all work to a degree. It’s free to send and receive when it doesn’t involve a credit card. Both the sender and the recipient must be on the same third-party system. It doesn’t work if you use PayPal and the person you’re paying uses Cash App. Either you also have to sign up for Cash App or they also have to sign up for PayPal. It gets unwieldy if you need to pay multiple people using all different third-parties.

Because these third-parties are private businesses, they have their agenda and they also must protect themselves. When you receive money in the third-party system, if you want to move it to your bank account, you may have to take a manual step to transfer it. The transfer may be subject to scrutiny and restrictions, and it can take several days.

Banks also got into the game. They funded their own middleman and created Zelle. Zelle provides the infrastructure but it leaves the customer-facing parts to the banks. Both the sender and the recipient interact with Zelle primarily through their bank’s online banking or mobile app. When both parties’ banks support Zelle, money leaves the sender’s bank account and it lands directly in the recipient’s bank account in minutes. Banks can choose to charge a fee for Zelle but most banks make it free to both send and receive. It works much better than using those tech companies. All large banks support Zelle (Chase, Bank of America, Wells Fargo, Citi, U.S. Bank, SunTrust, PNC, …). Some smaller banks and credit unions signed up as well. See the full list on Zelle’s website.

This came up when I needed to set up paying rent to my landlord. If I use my bank’s bill pay service, the bank will mail a paper check. My landlord lives in different places at different times of the year. If I pay him electronically, it goes into his bank account no matter where he’s at. Because I have everything else on autopay, I’d like to schedule the rent payments to go out automatically on a set date every month.

To my surprise, finding a bank that can do this was a challenge. Each bank sets its own policy on what it makes available through Zelle. Not all banks chose to support scheduling recurring Zelle payments. Those that support it have a low limit on how much you can send. For example, Navy Federal Credit Union allows sending a maximum of $2,500 every 30 days, and some banks allow sending only $500 per day. Bank of America allows sending up to $3,500 per day and up to $20,000 every 30 days through Zelle, but it doesn’t support scheduling automatic monthly payments. These limits aren’t inherent with Zelle. Different banks chose to impose different restrictions.

If your recipient’s bank supports Zelle, it works well for smaller payments, such as paying friends for shared expenses or paying a gardener. The low limits set by banks and their inconsistent support for scheduled payments make it more difficult to use Zelle for paying rent. Because Bank of America has a higher limit but it doesn’t support scheduling recurring payments, I have to set a calendar reminder and pay manually each month. It’s not the end of the world but I really wish it could be automated.

One important caveat for using Zelle and other third-parties for person-to-person payments is that you have to be absolutely sure you’re paying the right person. If you mistype an email address or phone number, the money can go to the wrong person and it’s difficult or impossible to get the money back. Some banks maintain a list of people you paid before. It helps for repeated payments but you still need to be extra careful when you’re paying someone for the first time. Some banks require typing the email address or phone number of the recipient every time. Doing it right last time doesn’t guarantee you’ll do it right this time. If you have a choice between different banks, use one that maintains a list of payees (Bank of America does).

The post Pay Rent Electronically By Zelle: Daily Limit and Scheduling Payments appeared first on The Finance Buff.

401k vs Pension: How To Make Your 401k Pay As Much As a Pension

[Updated with recent numbers from Vanguard.]

For the most part, 401k plans replaced pension as the prevailing vehicle for people’s retirement. Surveys and studies show very bleak numbers. The balances in 401k and IRAs aren’t nearly enough to pay for a comfortable retirement as the previous generation’s good ol’ pension once did.

Most public sector employees still get a pension. This often brings envy. People who don’t get a pension and don’t get enough from their 401k’s are increasingly unwilling to pay those who do.

It also leads to some people saying the 401k system is a failed experiment and that we are better off with a pension. Why can’t 401k and IRAs provide as much retirement income as a pension? There are many reasons such as:

Not all companies offer a 401k (not all companies offered a pension in the past either).Expensive funds and hidden fees in 401k plans (see how to uncover hidden fees in your plan).Volatile investment returns.People don’t understand investing.

These are all true. The biggest reason though, I would say, is that people don’t want 401k and IRAs to provide as much retirement income as a pension once did. In other words, 401k and IRAs don’t succeed because people don’t want them to succeed.

I came to this conclusion from reading Vanguard’s report on the 401k-type plans it manages: How America Saves. It shows in aggregate how much people contributed to their 401k plans, how much people accumulated in their 401k plan accounts, how much they traded in their accounts, etc. Vanguard publishes this report every year.

I highlight these interesting statistics:

24% of employees don’t contribute. 50% of employees younger than 25 don’t contribute.6% of employees with an income of greater than $150,000 don’t contribute.The median employee contribution rate is 6%.21% of employees contribute more than 10%.12% of employees contribute the maximum allowed by law.

Remember the participants covered by the Vanguard report (a) have a 401k plan, and (b) have low-cost funds from Vanguard. The picture is very clear. If people don’t contribute to their 401k’s or if they don’t contribute enough, they aren’t going to have enough in their accounts to cover their retirement.

How were pension plans able to do better? I once worked in the employee benefits department at a large employer with a pension plan. The annual funding to the pension plan came out to about 20% of the total payroll. To the employer, whether it was cash salary or pension contributions, it was all money coming out of the employer’s pocket as the employee compensation costs. For each $100 the employees earned in salary, the employer paid another $20 into the pension plan. The employees actually earned $120. The company was basically automatically putting 20 / 120 = 17% of an employees’ compensation into the pension plan. There wasn’t any choice. That 17% went in no matter what. It was forced savings.

When competition forced the employer to freeze the pension plan, all employees basically got a pay cut. The company no longer paid the $20. With a 3% 401k match, they were now paid 103 instead of 120. That was a 14% pay cut. Instead of taking the pay cut across the board and still saving the same percentage of the new total compensation for retirement, employees took a large part of the pay cut directly from retirement savings. After saving 6% in a 401k and receiving a 3% match, their cash salary was down from 100 to 94, but retirement savings were cut more than half from 20 to 9. When you cut your retirement savings in half, of course your 401k wouldn’t be able to pay as much as the old pension.

Why, when faced with a 14% pay cut, would people take the majority of the cut directly from retirement savings? People’s behavior revealed a preference for more cash today. If the employer didn’t have a pension plan and it just paid $120 to the employees as cash, the employees probably wouldn’t have contributed $20 toward retirement anyway. In other words, the old pension setup forced the employees to save for retirement more than they would’ve done themselves.

Is it bad to prefer cash today over money for retirement in the future? I’m not the one to judge. I subscribe to the philosophy of “live and let live.” If people want to spend more when they are young and spend less when they are old, what’s wrong with that? Why should an employer force them to save for retirement more than they wanted to?

Now, back to the question in the title. How do you make your 401k pay as much as a pension? One word: contribute. It takes about 15-20% of your pay to get to the level a typical pension plan once paid. If you want to achieve the same level of retirement income, you will need to target the contributions at 15-20% of your pay, counting your employer match.

The Vanguard report says that including employer match, employees with an income between $50k and $100k should save at least 12% of income; 15% of income if the income is over $100k. Given the uncertainty over Social Security and salary growth, I would bump these numbers up by a few percentage points.

Next time you hear “people used to have a pension,” think “people used to save 15-20% of their pay.” Nothing stops you from doing so today, unless you don’t want to.

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CARES Act Charity Donation Deduction: Ongoing or Only 2020?

While trying to solve one mystery in CARES Act Charity Donation Deduction: $300 or $600 for Married? I accidentally introduced another mystery. Is the deduction ongoing until the law changes again or is it a one-off for only 2020?

The text of the CARES Act said (bold added by me):

(22) CHARITABLE CONTRIBUTIONS.—In the case of taxable years beginning in 2020, the amount (not to exceed $300) of qualified charitable contributions made by an eligible individual during the taxable year.

CARES Act (page 65)

Because it said “years” (plural) and it gave no end-date, I thought this was an ongoing deduction. Tax attorneys at White & Case LLP wrote in April on Bloomberg Tax (bold added by me):

For individual taxpayers who do not itemize deductions, the CARES Act creates a new and seemingly permanent above the line deduction of up to $300 (additional to the standard deduction) for cash contributions made to qualifying charities.

Historic CARES Act Will Have Significant Impact on Companies, Individuals, Bloomberg Tax

However, reader MDM pointed out in a comment that the “taxable years” refer to fiscal years that can start on different dates in a year, and all those fiscal years must begin “in” 2020. He said if Congress wanted this to be an ongoing deduction they would’ve said “taxable years beginning after December 31, 2019.”

So what is it? An ongoing deduction or a one-off for only 2020?

The IRS Form 1040 draft instructions that solved our previous mystery doesn’t help. That document is specifically for 2020. It doesn’t say anything about 2021 and beyond. I turned to my trusted source Wolters Kluwer. Wolters Kluwer publishes guides for tax professionals. They wrote in August (bold added by me):

To encourage individuals to give more during the COVID-19 pandemic, Congress provided an incentive to non-itemizers to make charitable contributions. For 2020 only, an individual may claim an “above-the-line” deduction for up to $300 in charitable donations. The legislation is unclear, but most observers assume that the dollar limitation is $600 for married individuals filing jointly.

Charitable Contributions Continue to Rise; Expansion of Above-the-Line Deduction Proposed by John Buchanan at Wolters Kluwer

While it wasn’t clear at that time whether the deduction is $300 or $600 for married filing jointly, it was clear the deduction is a one-off for only 2020.

The Joint Committee on Taxation is a nonpartisan committee of Congress staffed by experienced economists, attorneys, and accountants, who assist Congress on tax legislation. They wrote in their detailed description of the CARES Act (bold added by me):

The provision permits an eligible individual to claim an above-the-line deduction in an amount not to exceed $300 for qualified charitable contributions made during a taxable year that begins in 2020. The above-the-line deduction is not available for contributions made during a taxable year that begins after 2020.

Description of the Tax Provisions of Public Law 116-136, the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act, The Joint Committee on Taxation

Oh well. I should learn how to read. Thank you, MDM, for pointing out the error.

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The Intersection Between Income and Wealth and The Role of Frugality

President-elect Biden’s tax plan drew a line at an income of $400,000 for taxing the wealthy. It prompted some comments as confusing income with wealth. Some people have a high income but they aren’t wealthy, because they live in areas with high costs of living or because they have high debt from mortgage and student loans and they haven’t had enough time to accumulate wealth yet. They’re referred to as HENRYs — High Earners, Not Rich Yet. On the other hand, some people with high wealth, especially those who are older and had the time to grow their wealth, no longer have a high income. Increasing taxes on higher incomes won’t affect them.

Meanwhile, Stanley and Danko said in their book The Millionaire Next Door that frugality, not high income, is the key to become wealthy. They said most millionaires became wealthy because they shunned flashy spending. If that’s true, increasing taxes on higher incomes won’t stop savers from becoming wealthy.

What’s the relationship between income and wealth? What percentage of people with a high income are HENRYs, and increasing taxes on them doesn’t really increase taxes on the wealthy? What percentage of wealthy people don’t have a high income, and they will be unscathed by a tax increase on higher incomes? Is The Millionaire Next Door correct in saying that wealth comes from frugality, not high income?

Survey of Consumer Finances

The Federal Reserve does a Survey of Consumer Finances every three years to look at the assets, liabilities, income, and demographic characteristics of U.S. families. I found a small gem at the end of one of their research notes — Wealth and Income Concentration in the SCF: 1989–2019. It shows the joint distribution of income and wealth. I reproduce the table here for easy reading:

Table C. Share of families in income group, by wealth group, 2019 SCF

Income groups
Wealth groups


Bottom 50
Next 40
Next 9
Top 1




Bottom 50
0.72
0.34
0.03
0.04


Next 40
0.27
0.56
0.46
0.05


Next 9
0.01
0.10
0.47
0.41


Top 1
0.00
0.00
0.05
0.49


All
1.00
1.00
1.00
1.00

The table divides income and wealth into four groups: bottom 50%, next 40% (top 10-50%), next 9% (top 1-10%), and the top 1%. The table should be read from top to bottom. For example, the last column means that among families in the top 1% in wealth, 4% of them have income in the bottom 50%, 5% of them have income in the top 10-50%, 41% of them have income in the top 1-10%, and 49% of them have income in the top 1%.

To put the percentiles in context, here are the approximate ranges for each group:

Income GroupWealth GroupBottom 50< $68k< $121kNext 40$68k – $201k$121k – $1.2 millionNext 9$201k – $531k$1.2 million – $11 millionTop 1> $531k> $11 million

Source:

Average, Median, Top 1%, and all United States Household Income Percentiles in 2020Average, Median, Top 1%, and all United States Net Worth Percentiles in 2020

To make the joint distribution table also readable from left to right, I created a hypothetical group of 10,000 families. 5,000 families are in the first column. Their wealth is in the bottom 50%. Multiplying the percentages in the rows puts them into different income groups. Doing the same for all the columns produces this table:

Income groups
Wealth groups


Bottom 50
Next 40
Next 9
Top 1
All




Bottom 50
3,600
1,360
27
4
5,000


Next 40
1,350
2,240
414
5
4,000


Next 9
50
400
423
41
900


Top 1
0
0
45
49
100


All
5,000
4,000
900
100
10,000

The totals don’t add up exactly due to rounding in the original table, but it’s close enough for our purpose. Now we can see a clearer picture of the relationship between income and wealth.

Reading across the “Top 1” row from left to right, we see if increasing taxes on the top 1% in income is used as a proxy to increase taxes on the top 1% in wealth, it has a “hit ratio” of about 50%. 50% of the families in the top 1% of income also have their wealth in the top 1%. The wealth of the other 50% caught by the higher taxes isn’t quite in the top 1% but it’s still in the top 10%. On the other hand, 50% of families in the top 1% in wealth will escape the higher taxes. In terms of paying less in taxes, the sweet spots are in the upper right parts of the table — asset rich, income poor.

When we look at each row, we see, as a group, wealth increases with income. An individual person in a lower income group may save more and have more wealth, but when you’re in a higher income group, you only have to be average. Although having a high income doesn’t automatically put you into the same group in wealth, it at least puts you one group below. 100% of the top 1% income group have their wealth in the top 10%. 95% of the top 10% income group have their wealth in the top 50%. It’s very difficult to advance one group from income to wealth. Only 10% of the “Next 40” income group have their wealth in a higher group. Only 5% of the “Next 9” income group have their wealth in a higher group.

Although income isn’t wealth, at least in these broad strokes, income is clearly the driver for wealth. If your income is there, your wealth isn’t too far behind. If your income isn’t there, it’s very difficult to move up by frugality. Conditioned on having the necessary income, frugality then plays its role. I heard this quote from Morgan Housel on a White Coat Investor podcast:

Wealth, in fact, is what you don’t see. It’s the car that’s not purchased. The diamonds not bought. The renovations postponed, the clothes forgone, and the first-class upgrade declined.

I have a feeling if a researcher goes to the DMV and randomly selects 100 registered Porsche owners and 100 registered Honda owners, they will find the Porsche owners as a group still have more wealth despite having spent more money on their cars.

The post The Intersection Between Income and Wealth and The Role of Frugality appeared first on The Finance Buff.

CARES Act 2020 Charity Donation Deduction: $300 or $600 for Married?

Since the Trump tax law in 2017 increased the standard deduction and capped the deduction for state and local taxes, the number of people who take the standard deduction increased from 70% of all taxpayers to 88%. I was part of the change. I switched to taking the much simpler standard deduction in the last two years. It also means I didn’t get an extra tax deduction for donating to charities. It was all included in the standard deduction.

The CARES Act passed earlier this year created a new above-the-line charitable contributions deduction for the 88% of all taxpayers who don’t itemize deductions. To qualify for this new deduction, the donations have to be in cash, and they have to be donated directly to charities. Donating household items to Goodwill doesn’t count. Donating appreciated stocks doesn’t count. Giving to a donor-advised fund doesn’t count. Because TisBest is officially a donor-advised fund, buying a charity gift card there probably doesn’t count either.

It’s a one-off deal for only 2020 (see CARES Act Charity Donation Deduction: Ongoing or Only 2020?). The deduction is capped at $300. While it’s clear when you’re single, it’s a little ambiguous whether it’s $600 per married couple filing jointly or still $300. Here’s the relevant part from the text of the CARES Act (bold added by me):

SEC. 2204. ALLOWANCE OF PARTIAL ABOVE THE LINE DEDUCTION FOR CHARITABLE CONTRIBUTIONS.

(a) IN GENERAL.—Section 62(a) of the Internal Revenue Code of 1986 is amended by inserting after paragraph (21) the following new paragraph:

‘‘(22) CHARITABLE CONTRIBUTIONS.—In the case of taxable years beginning in 2020, the amount (not to exceed $300) of qualified charitable contributions made by an eligible individual during the taxable year.’’.

CARES Act (page 65)

Because it said “individual,” a literal reading may interpret it as $600 per married couple filing jointly. From the TaxACT blog:

Thanks to federal coronavirus relief legislation, taxpayers are now able to take advantage of a new deduction for donating to qualifying charities — up to $300 for individual filers and up to $600 for married couples.

However, some sources said it’s still $300 for married filing jointly. From Kiplinger:

The CARES Act, among other coronavirus relief efforts, has instituted a provision allowing people to deduct $300 for charitable contributions. If you are married and filing jointly, your deduction is still limited to $300.

So what is it when you’re married filing jointly? $300 or $600? The IRS released the Form 1040 draft instructions last week. Now we have the definitive answer on page 29 (bold added by me):

If you don’t itemize deductions on Schedule A (Form 1040), you (or you and your spouse if filing jointly) may be able to take a charitable deduction for cash contributions made in 2020.

Enter the total amount of your contributions on line 10b. Don’t enter more than:
• $300 if single, head of household, or qualifying widow(er);
• $300 if married filing jointly; or
• $150 if married filing separately

That resolves it. The above-the-line deduction for 2020 is capped at $300 per tax return whether you’re single or married filing jointly. It’s capped at $150 each if you’re married filing separately.

[Update] Just to make it more confusing, Congress passed a new law that extended this deduction to 2021, and the cap in 2021 for married filing jointly is increased to $600. The cap in 2020 for married filing jointly is still left at $300. See 2021 $300 Charity Deduction For Non-Itemizers $600 Married.

The post CARES Act 2020 Charity Donation Deduction: $300 or $600 for Married? appeared first on The Finance Buff.

CARES Act Charity Donation Deduction: $300 or $600 for Married?

Since the Trump tax law in 2017 increased the standard deduction and capped the deduction for state and local taxes, the number of people who take the standard deduction increased from 70% of all taxpayers to 88%. I was part of the change. I switched to taking the much simpler standard deduction in the last two years. It also means I didn’t get an extra tax deduction for donating to charities. It was all included in the standard deduction.

The CARES Act passed earlier this year created a new above-the-line charitable contributions deduction for the 88% of all taxpayers who don’t itemize deductions. To qualify for this new deduction, the donations have to be in cash, and they have to be donated directly to charities. Donating household items to Goodwill doesn’t count. Donating appreciated stocks doesn’t count. Giving to a donor-advised fund doesn’t count. Because TisBest is officially a donor-advised fund, buying a charity gift card there probably doesn’t count either.

It isn’t a one-off for only 2020. This deduction is available every year until Congress changes the law again. The deduction is capped at $300. While it’s clear when you’re single, it’s a little ambiguous whether it’s $600 per married couple filing jointly or still $300. Here’s the relevant part from the text of the CARES Act (bold added by me):

SEC. 2204. ALLOWANCE OF PARTIAL ABOVE THE LINE DEDUCTION FOR CHARITABLE CONTRIBUTIONS.

(a) IN GENERAL.—Section 62(a) of the Internal Revenue Code of 1986 is amended by inserting after paragraph (21) the following new paragraph:

‘‘(22) CHARITABLE CONTRIBUTIONS.—In the case of taxable years beginning in 2020, the amount (not to exceed $300) of qualified charitable contributions made by an eligible individual during the taxable year.’’.

CARES Act (page 65)

Because it said “individual,” a literal reading may interpret it as $600 per married couple filing jointly. From the TaxACT blog:

Thanks to federal coronavirus relief legislation, taxpayers are now able to take advantage of a new deduction for donating to qualifying charities — up to $300 for individual filers and up to $600 for married couples.

However, some sources said it’s still $300 for married filing jointly. From Kiplinger:

The CARES Act, among other coronavirus relief efforts, has instituted a provision allowing people to deduct $300 for charitable contributions. If you are married and filing jointly, your deduction is still limited to $300.

So what is it when you’re married filing jointly? $300 or $600? The IRS released the Form 1040 draft instructions last week. Now we have the definitive answer on page 29 (bold added by me):

If you don’t itemize deductions on Schedule A (Form 1040), you (or you and your spouse if filing jointly) can take a charitable deduction of up to $300 for cash contributions made in 2020 to organizations that are religious, charitable, educational, scientific, or literary in purpose. See Pub. 526 for more information on the types of organizations that qualify. A deduction can’t be taken for a contribution to an organization described in IRC 509(a)(3) or for the establishment of a new, or maintenance of an existing, donor advised fund. Also, contributions of noncash property and contributions carried forward from prior years don’t qualify for this deduction. See the Instructions for Schedule A and Pub. 526 for more information on those types of contributions. Enter the total amount of your contributions on line 10b. Don’t enter more than $300.

That resolves it. The above-the-line deduction is capped at $300 per tax return whether you’re single or married.

The post CARES Act Charity Donation Deduction: $300 or $600 for Married? appeared first on The Finance Buff.

Fidelity Extended ETF Orders in Dollars with Fractional Shares to Website

Fidelity started accepting ETF orders in dollars with fractional shares back in February but it was available only in their mobile app (see Fidelity Accepts ETF Orders in Dollars with Fractional Shares). Now Fidelity extended the same functionality to online trading on their website.

When you buy or sell an ETF at most other brokers, you have to do it in whole shares. If you’d like to invest $3,000 in an ETF and the price of the ETF is $53.69 per share, you have to calculate first how many shares it is. Then you place an order for either 55 shares or 56 shares, which will cost you either $2,952.95 or $3,006.64, but not $3,000 exactly. When you place an order in dollars to buy $3,000 worth of this ETF at Fidelity, you don’t have to care what the price is per share. Fidelity will do the math and give you 55.876 shares. You will pay $2,999.98, with two cents left from your $3,000. Buying or selling in dollars is more natural than in shares.

There are two paths to access the screen for placing an order in dollars.

Pull-Down Menu

If you use the pull-down menu, click on Accounts & Trade, and then Trade.

If you haven’t seen the Simplified Ticket before, you will see a banner message saying fractional shares trading is available on the Simplified Ticket. After you click on the link for the Simplified Ticket once, it will default to the Simplified Ticket next time.

On the Simplified Ticket, you can choose to place orders either in shares or in dollars, as a market order or a limit order. If you choose to place the order in dollars as a limit order, the limit order is only valid for one day. The order will expire if it can’t be filled before the end of the day. Other order types such as Good ‘Til Canceled (GTC), On the Open, On the Close, etc. aren’t available for an order in dollars.

Trade Pop-up

If you use the Trade quick action link below the Accounts & Trade menu, you get a small pop-up for entering trades.

This pop-up only accepts orders in shares. Click on the “Switch to the expanded Trade Ticket” link at the bottom. It actually sends you to the Simplified Ticket, where you can place orders in dollars.

Sell All Shares

Before you can buy and hold fractional shares, it used to be that when you’d like to sell all shares in a holding, you enter an order to sell all the whole shares, and the remaining fractional share will be sold automatically. For example, if you have 55.876 shares in an ETF and you’d like to sell all your shares, you enter an order to sell 55 shares. When this order settles, your 0.876 shares will also be sold at the same price. There’s no way to hold less than one share. This is still the case at some other brokers.

Now that Fidelity lets you buy and sell in dollars, which can leave you with less than one share, they don’t automatically sell your fractional share anymore. If you have 55.876 shares and you enter an order to sell 55 shares, you will still hold the remaining 0.876 shares. If you’d like to sell all your shares in a holding, you can explicitly choose the “Sell All Shares” option.

The post Fidelity Extended ETF Orders in Dollars with Fractional Shares to Website appeared first on The Finance Buff.