Jonathan Clements's Blog, page 414

Capital Punishment

MY CLIENT ROSTER includes investors who have suffered enormous losses on their stock market investments. To ease their discomfort, I steer the conversation to what they’re entitled to deduct for capital losses. While the IRS imposes strict limits on simply writing off such losses, I assure my clients that there are perfectly legal, IRS-blessed opportunities to sidestep these restrictions.

The big hurdle is a deduction cap of $3,000 for both married couples and single filers. The cap drops to $1,500 for married persons who file separately from their spouses. This is the amount of capital losses that you can use to reduce your ordinary income—a wide-ranging category that includes income received from sources like salaries, pensions and interest. These dollar limits haven’t increased since they went on the books in 1978, when Jimmy Carter was in the White House.

In my experience, many individuals focus only on the $3,000 ceiling—and are completely unaware that the tax code allows taxpayers to use their investment losses to offset capital gains on other kinds of assets.

For instance, taxpayers can offset losses realized on stock and bond sales in their taxable account against gains on sales of capital assets other than stocks and bonds. This opportunity opens up many possibilities: You might offset your stock market losses against gains on sales of collectibles, personal residences and vacation homes.

A client I’ll call Louise met with me to discuss the pending sale of her personal residence. She expects her profit to considerably exceed the applicable exclusion amount for sellers (up to $500,000 for married couples filing jointly, and up to $250,000 for single individuals and married couples filing separate returns). My no-brainer advice: She should realize existing paper losses on some of her stocks and offset those losses against the taxable part of the gain from her home sale.

How much is Louise allowed to deduct and when? It depends. The law lets Louise use capital losses to erase taxes on capital gains realized during the same tax year, up to the total amount of gains. The IRS couldn’t care less whether her gains and losses are a mixture of short- and long-term.

Suppose Louise actively trades stocks and makes many bad bets. Her net capital losses greatly exceed her capital gains. The good news: She won’t have to pay taxes on any of her realized capital gains. But how much additional tax relief can she count on for 2017? Not all that much. She gets to offset net losses against no more than $3,000 of ordinary income.

How quickly will Louise be able to apply her unused losses, above that $3,000, to 2018 and succeeding years? Consider an example: For 2017, active trader Louise has losses of $260,000 and gains of $240,000, with $40,000 from selling some winning stocks and $200,000 from the gain on the sale of her home, over and above the exclusion amount. Thanks to her losses, Louise saves $6,000 in taxes on her winning stocks and $30,000 in taxes on her home sale, assuming she would have paid capital gains taxes at 15%.

After offsetting those gains, Louise is left with a net loss of $20,000 in 2017. On Form 1040’s Schedule D, she subtracts $3,000 of the loss from ordinary income and is allowed to carry forward $17,000 from 2017 into 2018. On 2018’s Schedule D, she uses the remaining loss (unless it’s offset by realized capital gains in 2018) to trim ordinary income by no more than $3,000 and then carries forward $14,000 from 2018 to 2019, and so on indefinitely.

Julian Block writes and practices law in Larchmont, NY, and was formerly with the IRS as a special agent (criminal investigator). His previous blogs include Unending Pain, Moving On and Late? That’ll Cost You 50%. This article is excerpted from Julian Block’s Year-Round Tax Savings, available at JulianBlockTaxExpert.com. Follow Julian on Twitter @BlockJulian.

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Working the Plan

WORKPLACE RETIREMENT ACCOUNTS can be confusing and intimidating. Often, human resources departments serve as the contact point for employees, yet HR folks rarely know much about the nuances of a plan’s investment options—and, in any case, they aren’t legally allowed to offer advice.

Not sure how to handle your 401(k) or similar employer-sponsored plan? My first step was determining how much to contribute per pay period, so that I could hit the $18,000 annual limit. To do this, my wife (who works in a school and automatically contributes 11% to a pension) and I made sure that we could afford our other expenses, without counting on this money. I believe retirement should be the top priority for most people—more important than a new car or even the children’s college tuition.

Next, I ensured that I collected the full match that my employer offered. I learned that if I contributed too much early in the year and hit $18,000 in October, I’d lose out on the match in November and December. Check with your 401(k) plan to see how they determine matching payments and what you need to contribute each pay period to get the entire year’s full match.

My plan offers both a traditional 401(k) and a Roth 401(k). I decided to split my contributions between the two as a hedge against uncertain future taxes. The deduction from the traditional 401(k) reduces my current taxable income, which is great, while the Roth builds an account that I can tap into during retirement without paying taxes. If I leave my company, I’ll need to roll each one into a separate account to keep them distinct.

Once I made all of the technical decisions, I was ready to invest. When I initially joined my company and looked at the funds, I sorted the 25 available and noticed they all had fees of at least 1%, except for Vanguard Group’s S&P 500 index fund, which was far cheaper, since it’s passively managed. I put all of my contributions into this one fund and figured I would use my personal accounts to invest in other market sectors. But I also gave feedback during an HR survey, requesting more options.

I don’t know whether my feedback had any impact or whether it was an already scheduled plan change, but three months later I noticed that five more Vanguard index funds were introduced, all with lower expenses than the other available choices. I reallocated my future contributions to match my overall philosophy. I split the majority of my money between the S&P 500 and an international index fund, with another 5% to 10% each in Vanguard’s small-cap, mid-cap and emerging markets index funds.

Zach Blattner’s previous blogs include Not So Fast and Growing Up (Part II). Zach lives in Cambridge, MA, and is a former teacher and school leader who now teaches English teachers as a faculty member at Relay GSE. He is a self-taught finance nerd who dispenses advice to his wife, friends, family and anyone else willing to listen. Follow Zach on Twitter @Mr_Blattnerz.

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This Week/Oct. 8-14

GET A FREE CREDIT SCORE. You can learn your score at sites such as Credit.com, CreditCards.com, CreditKarma.com, CreditSesame.com, NerdWallet.com, Quizzle.com and WalletHub.com. Scores are also available from Capital One, Chase and Discover, even if you aren’t a customer. Not all these sites will tell you your FICO score—the most widely used scoring system.

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October’s Newsletter

IT’S BEEN AN EXTRAORDINARY eight-year stock market run. Result: Many of us find ourselves far closer to our target retirement nest egg. Maybe we even have enough salted away to call it quits. Does that mean we should declare victory and cut back our portfolio’s risk level? I wrestle with that issue in October’s newsletter.

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Enough Already

“WHEN YOU’VE WON THE GAME, stop playing with the money you really need.” That’s something my longtime friend and fellow author William Bernstein is fond of saying—and lately it’s been on my mind.

There’s been much handwringing over 2017’s stock market rally. Looked at objectively, it hasn’t been that startling. As of Sept. 29, the S&P 500 was up 14.2% for the year-to-date, with dividends reinvested—a good year, but nothing compared to the 25%-plus years we saw in 1991, 1995, 1997, 1998, 2003, 2009 and 2013. Moreover, this year’s gain follows two years when the market notched an average 6.5% a year, so arguably we aren’t exactly on a hot streak.

On the other hand, the S&P has soared an average 13.8% a year over the past eight years and U.S. stock market valuations are undoubtedly rich. Moreover, it appears memories of the 2007-09 market collapse have finally faded. It took many years and a huge stock market rally, but it seems not owning stocks is now the one investment strategy that’ll draw looks of pity at the neighborhood cocktail party.

In recent years, I’ve comforted myself by occasionally rebalancing back to my portfolio’s target percentages and by noting that foreign markets—which account for more than 40% of my stock exposure—are much better value. But lately, this hasn’t been all that comforting.

The reality is, if U.S. stocks dropped sharply, foreign stocks would likely also swoon and my nest egg would take a huge hit. To make matters worse, I have less time to recover from a market decline and less regular monthly savings to take advantage of lower stock prices.

Ten years ago, the world looked very different. My 44-year-old self would be rooting for a bear market, knowing that I was still saving voraciously and still had decades to retirement. But I’m not 44, but rather 54, and as I eye retirement, I think about Bill Bernstein’s comment. If I have already won the game, why would I keep playing?

Risk Unrewarded. As I see it, if you own a globally diversified portfolio of index funds, there are only four legitimate reasons to ease up on stocks. First, you might sell as part of a regular rebalancing program. Second, you might unload stocks as you approach retirement—and continue to do so once retired—as you look to draw income from your portfolio. Third, you might sell if you no longer need to take so much risk, because you’re financially well ahead of where you need to be. Fourth, you should probably lighten up on stocks if you can’t afford to take so much risk, because the consequences of a big market decline would be so devastating.

In a 2015 article for The Wall Street Journal, Bill offered a series of benchmarks: You should aim to have at least 25 years of required portfolio withdrawals socked away if you retire at age 60, 20 years if you retire at 65 and 17 years if you retire at 70. Need $40,000 from your portfolio and plan to call it quits at 60? Bill’s rule suggests you need a $1 million portfolio.

“The fear, of course, is that we arrive at modest long-run stock returns by having atrocious short-run results.”

What if your nest egg is smaller than Bill’s benchmarks? He argues you should favor a more conservative portfolio, perhaps with 60% in bonds. That way, you run less risk that your need for income—coupled with a vicious stock market decline—will eviscerate your portfolio and leave you eating cat food.

Those who are at, or comfortably above, Bill’s benchmarks have more of a financial cushion—and can afford to keep more in stocks. But should you? You’ve won the game. Should you continue to play aggressively, with a view to enriching your heirs or your favorite charities, or dial down the risk, so you can live out your days knowing that only financial Armageddon could derail your comfortable retirement? Bill’s article is available online, but you may need to subscribe.

Calling It Quits. I think Bill’s benchmarks are a great guide. But I’d throw in an additional caveat: It strikes me that the range of possible U.S. stock returns is especially large right now. As I discussed in a relatively recent blog, we have unusually high valuations, historically fat profit margins and an economy destined to grow slowly because the labor force is growing slowly.

This is a recipe for modest long-run stock returns. Those returns should be better than bonds, which will likely fare even worse, given today’s low bond yields. And if that’s what we get every year—modest stock returns that are somewhat better than bonds—we should consider ourselves lucky.

The fear, of course, is that we arrive at those modest long-run stock returns by having atrocious short-run results. That’s not a problem for younger workers, who will be able to buy shares at bargain prices. But it’s a grave danger for those near or in retirement: Selling stocks at fire-sale prices, either out of panic or because you need income, can cause massive financial damage.

What are the portfolio implications? My assumption is that a global stock portfolio will return 5% to 6% a year over the long haul and a mix of high-quality corporate and government bonds might return 2.5% to 3%, while inflation runs at 2%. Let’s assume results come in at the lower end of the range, with stocks at 5% and bonds at 2.5%.

Let’s also assume we’re aiming to fund a 30-year retirement. We want a portfolio that permits us to withdraw 4% in the first year, equal to $4,000 for every $100,000 saved, and thereafter allows us to step up our annual withdrawals with inflation. To make it through 30 years without running out of money, our investments need to earn an average 3.4% a year if inflation is 2%. Based on my assumed returns, investors could hit that 3.4% with a mix of 36% stocks and 64% bonds.

This calculation is, I admit, a tad unrealistic, because it assumes we earn the same return year after year. Depending on whether we get good or bad results early in retirement, we might need a lower or higher average return. Still, it gives a sense of how conservative investors could potentially be.

And yet I’m not about to cut my stock holdings to 36%. Not even close. Partly, it’s because I would like to earn more than 3.4%, so there’s more money left over for my children. Partly, it’s because my retirement might last longer than 30 years—and taking a little additional risk should deliver a higher portfolio return and give me a financial cushion.

But truth be told, I’m also not yet ready to quit the game—which suggests that perhaps I’m not being entirely rational.

Getting Exercised

MY GOAL IS TO WORKOUT for at least 40 minutes every day, pretty much no matter what’s happening in my life. I figure that, if I’m saving for a 30-year retirement, I should make sure my body lasts almost as long as my money. During my daily 40 minutes, I get to see my fellow humans at play. This can be a source of some consternation. A few examples:

Those who hold phone conversations while running. Are the folks on the other end of the line at all bothered? Or did they dial a 900 number and are happily paying to be recipients of heavy breathing?
Those who slump, unmoving, on the exercise equipment for minutes at a time. Surely the couch would be a better place to take a nap?
Those who eat while exercising. I remember a gentleman on the neighboring exercise bike at a Beverly Hills hotel, who talked to a friend and ate a muffin while slowly pedaling. All I could think was, “speed up, my good man, or you’ll take on more calories than you’re shedding.”

September’s Greatest Hits

HERE ARE THE SEVEN most popular blogs from last month:

Stop Thief
Driving Down Costs
Parting Thoughts
A Price on Your Head
Investment Taxes: 10 Questions to Ask
Late? That’ll Cost You 50%
Moving On

September also saw continued heavy traffic for the various 10 question blogs that HumbleDollar first published in July and August. Also check out two other lists, one with the 10 most popular blogs for 2017’s first nine months and the other showing the top blogs for this year’s third quarter.

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Self-Tithing

WHEN MY SISTER GRADUATED from physicians’ assistant school earlier this year, I gave her a journal, the pretty, unmarked, paper-substantive kind that every female loves. Inside, I wrote five things that I wish I’d known, or am glad I knew, when I got my bachelor’s in 2006. Here was the first:

I’m gonna call it self-tithing. Ya know: Basically, what Mom and Dad taught us to give to the church, I’m telling you to give to yourself. Save 10% to 20% of every paycheck, and you’ll be surprised how fast it grows. (Just don’t tell Mom.)

Among the many things that I’ve needed to “learn my way through” since college, there are some I’ve done well. Among them: Living the advice I gave my sister. I can still remember how paltry 10% of my first paycheck felt—and how ineffective I felt “saving” that amount of nothing. What’s $28,000 a year, minus income and payroll taxes, divided into two payments per month during each of 12 months? I’ll answer my own question: So paltry that I’ve misremembered the exact tiny amount.

I was living in Washington, DC, at the time, renting a room about the size of my current bathroom. My Goodwill carpet didn’t fully cover the cement floor and a $299 Ikea mattress seemed an incredibly irresponsible splurge. Let’s just say the itty-bitty living space matched my savings.

Back then, I often stole dinner from my employer’s kitchen. Expired chili is actually better than you’d think. This was back in the day before addressing the employee experience with grass-fed beef was a thing. All that to say, at the time, saving did not feel normal or natural.

“I don’t have the budget,” I remember arguing with myself. “I can barely afford rent!”

“I know, I know,” I self-responded. “But starting the habit later will be that much harder.”

Somehow, I listened to myself. Or maybe more accurately, I listened to parents-in-my-head who’d taught me to tithe and save. Since then, I’ve mostly saved 20%, mostly for myself and 501(c)(3) giving.

I shared these things with my love-you-like-a-sister over a Nashville dinner, while sipping real champagne bubbles and sitting face to face.

Set up an automatic transfer. Like literally. Have your employer funnel a portion of every paycheck—before you see it—to an entirely separate account. Live your life like the money’s not there.

Like much good advice, I knew following it isn’t easy. So I also told her how the approach could eventually pay off. In my case, saving up to 20% positioned me to buy and remodel a condo in incredible and incredibly expensive Silicon Valley. I relish the sensation of self-sourcing my own security and home. The place isn’t huge. It isn’t brand new. But as a first-time homeowner, I couldn’t see it as more lovely.

Caitlin Roberson, author of 30 Ways to Happy, lives and works in Silicon Valley, where she helps top tech executives change the world through business storytelling. Caitlin obsessively lifts weights and attends hip-hop dance classes, so she can tithe in Napa, guilt-free. You can learn more about her at CaitlinRoberson.com and follow her on Instagram @CRobRobber.

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Giving: 10 Questions to Ask

HAVEN’T GIVEN MUCH THOUGHT to estate planning and charitable giving? Here are 10 questions to jumpstart your thinking:

Can you afford to give away money now? You shouldn’t gift large sums to your children or charity unless you’re confident you have enough for your own retirement. There’s no limit on gifts to charity, though your annual tax deduction may be capped. For gifts to family members, you might take advantage of the annual gift-tax exclusion, currently $14,000.
Do you have the right beneficiaries listed on your retirement accounts and life insurance? Your individual retirement account and employer’s retirement plan might hold the bulk of your savings, so it’s crucial these accounts pass to the right folks.
At the end of your life, who do you want to make medical decisions on your behalf and how far would you like doctors to go in attempting to prolong your life? You should codify these wishes in a health care power of attorney and living will.
Do you have a will? According to a 2016 Gallup survey, just 44% of U.S. adults have one.
Are you worrying unnecessarily about federal estate taxes? Thanks to today’s $5.49 million estate tax exclusion, IRS statistics suggest just one out of every 530 deaths will likely trigger federal estate taxes. Indeed, you should review your estate plan if it was designed to avoid federal estate taxes—but was drawn up before the sharp increase in the federal estate tax exclusion since 2001, when the exclusion stood at just $675,000.
Does your state impose an estate or inheritance tax? A variety of websites keep a comprehensive list, including McGuireWoods.com and Nolo.com.
Should you keep your Roth IRA for your heirs? That pool of tax-free money could make a great bequest. During your lifetime, you might also help your children or other young family members fund a Roth, assuming they have earned income. With decades of compounding ahead of them, even small sums invested today could grow to become significant wealth.
Are the charities you support well-run? Investigate them by heading to sites such as CharityNavigator.org and GuideStar.org. A crucial question: Of the dollars you donate, what percentage ends up in the hands of the people you’re hoping to help?
Could you save even more on taxes by donating appreciated assets—or, if you’re over age 70½, giving away part of your annual required minimum distribution?
Have you talked to your adult children about your estate? You should discuss how much they will likely inherit, how you would like the money used, where key documents are located and what your wishes are regarding life-prolonging medical procedures.

This is the 10th blog in a series. Be sure to check out the earlier articles.

Follow Jonathan on Twitter @ClementsMoney and on Facebook.

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Hunting for Happiness

I HAVE NEVER BEEN under the illusion that happiness was a simple matter of more money and more material goods. But I did question where happiness could be found.

When I was young, I saw poverty at its most extreme in newly formed Bangladesh, where my family lived for four years during the 1970s. People struggled each day to stay alive and were lucky to find food and shelter.

As an adult traveling through Mexico, I have seen similar poverty. For these families, each day must be as grim as the last and presumably more money would buy happiness. But not every family I’ve met has been so impoverished. These families, who had the basic necessities of life, seem happy with what they have—and just as happy as those I see around me in the suburbs of Washington, DC. They don’t need the material goods that so many of us in the U.S. pursue in hopes of finding happiness. Instead, their happiness seems to lie in having family around them, all under one roof.

It’s a lesson that influences how I lead my own life. During my travels through Mexico with friends, we eat at roadside restaurants. You can tell which are the best, because you see more locals congregating. The food is as good as, if not better than, what you might find in a nearby restaurant that’s more upscale. We also typically stay at basic hotels, where our room might consist of nothing more than a bed with a ceiling light and fan. The bathroom facilities are outdoors.

On my most recent trip, we opted for a hotel that was slightly more luxurious (keep in mind, that’s relative). As I took a walk along the beach early one morning, I wondered if this would improve or diminish the level of happiness I got from the experience. It didn’t. That’s not to say that staying in a five-star hotel or eating at a similarly rated restaurant won’t be a happy experience. It probably will be.

What it says is that you don’t need to spend extra to find happiness. For me, it isn’t the fancy hotels and restaurants, but rather my relationship with my fellow travelers. That’s where I find happiness. It’s the experiences along the way which bring us together. It’s the time with friends and family, the laughter and conversation, not the dollars we spend.

Nicholas Clements is one of Jonathan’s older brothers. He is retired and lives just outside Washington, DC. His previous blogs include Help Wanted, On Our Own and Growing Up (Part III) . Follow him on Twitter @MDScaper .

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Top 10 Blogs: Third Quarter

OVER THE PAST THREE MONTHS, readers flocked to our series of blogs on 10 questions to ask. What else caught their eye? Many of the other top 10 blogs focused on investment issues, perhaps reflecting a summer of stock market nervousness, even as share prices edged higher.

Retirement: 10 Questions to Ask
Fooled You
Measure for Measure
Happiness: 10 Questions to Ask
Looking Bad
Protection Money
Safety Net: 10 Questions to Ask
Stocking Up
Savings: 10 Questions to Ask
Growing Up (Part II)

What have been the most popular blogs so far this year? Check out yesterday’s post and you’ll see the top 10 for 2017’s first nine months.

Follow Jonathan on Twitter @ClementsMoney and on Facebook.

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This Week/Oct. 1-7

CONSIDER A ROTH CONVERSION. You should have a good idea of your taxable income for the current year. Is it less than normal, so you’ll end up in a lower tax bracket? To take advantage, consider converting part of your traditional IRA to a Roth, where the money will grow tax-free thereafter. One warning: Make sure you have the necessary cash to pay the resulting tax bill.

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