Flatten The Curve

Chances are, if you live in the US, you aren’t taking Coronavirus seriously. I have always enjoyed deep diving into topics, including voracious reading. This topic is no different – I’ve been following developments since New Years’ Eve. Based on my conversations with people in my life, most people have not been studying this and are woefully uninformed. The government is trying not to panic people, so they aren’t giving the whole story. The media is trying to sell ads, so they are promoting whatever accomplishes that goal.

I have found the best sources of information are from people around the world that are on the ground – doctors, virologists, microbiologists, even regular citizens reporting on what they see.

To that end, I am going to list some sources of information I have found interesting and helpful. Spreading the word is key to keeping this virus under control. Flatten the curve!! https://www.sciencealert.com/dragging-out-the-coronavirus-epidemic-is-important-in-saving-lives

All from Twitter:

@BNODesk – BNO Newsroom. By far the best nonpartisan reporting I’ve seen on the facts from around the world

@aliostad reporting regarding Iran

@YonhapNews – Yonhap News Agency headquartered in Seoul, South Korea

@IranNW – Iran News Wire

@MackayIM – Ian M Mackay, PhD – from Brisbane Australia, but some of the best medical analyis and links I’ve seen

@Mlipsitch – Marc Lipsitch, infectious disease epidemiologist and microbiologist

@kakape – Kai Kupferschmidt Molecular Biologist

@DrEricDing – Eric Feigl-Ding, Epidemiologist

Inform yourself. Information is power. Social distancing saves lives by reducing the strain on our health care system. FLATTEN THE CURVE.

Tax Rate Arbitrage For Taxable Income $170K-$320K

If you are married and your joint taxable income is between $170,000 and $320,000 you are in the 24% tax bracket. This means the wage income you earn between $170,000 and $320,000 is taxed at 24%. If your income will fall in between these limits for the foreseeable future, you should consider whether or not you think your marginal tax rate will continue to be as low as 24% over the next 0-10 years. Note that under current law, the marginal tax rate on that level of income is set to increase to 28%-33% starting in 2026. That’s a huge difference in taxes paid!!

If you are earning income at that high rate ($170,000 – $320,000), then you are likely contributing up to $19,000/year ($26,000 if over age 50) to your regular 401(k). If this is you, realize that you are saving 24% on these contributions, and will pay the tax rate in effect the year you withdraw the contributions. Under current law, your combined IRA distributions (and keep in mind you are REQUIRED to be taxed on a portion of your IRA/401(k) at age 70.5) plus Social Security plus investment income will need to be less than about $76,000 for this to make financial sense. (The 25% tax bracket goes back into effect in 2026 at about $76K, plus adjustments for inflation).

It is important to be aggressively saving as part of any retirement strategy, but perhaps the regular 401(k) plan is not your best option. Consider switching part or all of your 401(k) saving to your employer’s Roth 401(k) option. Contributions to Roth 401(k)s are made after-tax, but grow tax-free during your lifetime (under current law). Be careful with this strategy, as it will increase your taxable income. You need to watch so you don’t exceed $320,000 in taxable income, thereby bumping into the 28% tax bracket. (Other bad things happen at taxable income > $320K, including the beginning of the phase-out of the qualified business income deduction for service based businesses. If you are age 63 or older, you also need to be aware how your taxable income will impact your future Medicare premiums).

If you have contributed to your regular 401(k) all year (or if your employer does not offer a Roth 401(k) option), and are now realizing this has all generated only a 24% tax deduction, you can make a partial Roth IRA conversion to effectively accomplish the same thing as if you had contributed to your Roth 401(k). Simply transfer assets from your IRA to your Roth IRA (continuing to pay careful attention so you don’t exceed $320K in taxable income).

Note that “taxable income” is all taxable income, less deductions for pre-tax items such as HSA contributions, medical/dental insurance, employer retirement plans, etc.; and less the standard deduction or itemized deductions, whichever applies.

Note also that this same concept applies to other tax brackets, as well.

The calculations to determine if this is a good strategy for your specific situation are complicated. I would not suggest making any moves until you have your financial advisor run a tax projection for you under each scenario.

(Dollar amounts used in this essay are in effect in 2019 and rounded for simplicity).

Safety Nets

Times have been good the past few years. There have been a few short setbacks in the stock market, but no major events that sapped investor optimism and led us into a prolonged period of pessimism.

Now is a great time to talk about your positioning for the next inevitable stock market decline. 2008-2009 was the steepest decline in recent memory, but it was relatively short – 17 months of declines in the S&P 500. The market decline from 2000-2002 was not as widespread, but was much longer – 30 months of declines. Stock market charts do not capture the depth and fear of these times, as things continued to get worse, day after day, month after month. Until they got better.

During each of these times of decline, the news of the day was largely pessimistic. Both in the boom times before and the bust times after, calls of “this time is different!” appeared in the press, used to argue that the boom/bust would continue indefinitely. Those are dangerous words! Beware, whenever you read them – raise your guard.

How do you protect yourself from what comes next in the market? What do you use as a safety net? I can think of several things:

1. Cash. Cash is always king. If you have a pile of cash on hand, you don’t need to worry immediately about job loss, down markets, up markets, etc. Make sure you have 3 months’ of expenses for your emergency fund in an interest-bearing account, and additional cash “ammo” in your investment account, available for deployment when the markets turn south once more.
2. Frugality. If your expenses are low, you need a lot less cash on hand in your emergency fund. If you expenses are low, you can accept a job paying less than what you were currently making and still pay your bills. Don’t be caught in the cycle of “needing” to earn a certain amount to keep your standard of living.
3. Work ethic. Don’t be that recently unemployed person that thinks they “deserve” a vacation, and spends their days binge watching Netflix for a few weeks before looking for a job. The early bird really does get the worm, and your ego and sense of self-worth will thank you for taking this to heart. This goes hand in hand with some work is better than none – don’t wait for the perfect opportunity.

Everything else builds from these. Having cash on hand will eliminate the need for short-term borrowing for emergencies. Being frugal will prevent you from buying that expensive car on credit, or a house at the top of your affordability limit. Not having those large debt payments will save you when the markets turn south, especially if you lose your job. A strong work ethic will result in income in good times and bad.

Whether or not you think we are close to our next market or economic decline in the business cycle, taking steps to shore up your personal safety net will ensure you are prepared.

One Health Insurance Option When Retiring Early

One of the most vexing problems for people who want to retire early is what to do about health insurance. The US is an employer based health system; most health insurance is provided by employers. It is very difficult and expensive to purchase health insurance outside of this system if you are under age 65. While there aren’t any easy answers to this problem, there may be an option for you.

Consider reducing your hours at your job instead of quitting – in many companies, you can keep your health insurance if you work 25 hours per week or more. This can be a HUGE cost savings compared to having to buy it on the open market. This 40% reduction in your working hours will also make a huge impact on your life, as you will have tons more time to do the things that really matter.

Another benefit of this approach is that you can contribute all your net income (up to the $19,000 2019 limits; $25,000 if you are over 50) to your 401(k)/Roth 401(k) or other benefits, such as ESPP or HSA.

For those of us over age 50, leaving our job completely can be scary. Often times our identity is tied up in our job. Reduces our working hours by 40% can provide us the opportunity to ease into retirement, while also keeping ourselves insured.

Supercharge Your HSA

Little known fact for those over age 55: In the year you turn 55, you can start contributing an extra $1,000 to your HSA, and so can your spouse! The trick is that your spouse must open and contribute to their own account.

The normal IRS limits for a family plan HSA (or a couple plan) is $7,000 per year (2019 limits). Your employer plus employee contributions cannot exceed this limit. However, in the year you turn age 55 until you sign up for Medicare, your limit increases to $8,000. The year your spouse turns 55, they can also add $1,000 (albeit to their own account, not your account), for a total of $9,000 per year in contributions! Even some professional tax software does not account for this correctly, so make sure you are getting the full tax benefit of your contributions.

Note that if you are not married, the extra over 55 limit is still $1,000. You just add the total $4,500 to your own HSA.

Why Contributing to Your 401k Might Cost You

I have heard a lot of advice for young FIRE seekers to contribute to their 401k even if they are only in the 15% tax bracket. Here is why that might not be the best financial advice:

Once you start collecting Social Security (hopefully at age 70 for maximum benefit), the extra income from required minimum distributions (or necessary-for-cash-flow distributions) from your 401k may cause your marginal tax rate to go up to 26-30%. To understand why, you have to actually prepare a tax projection (a mini tax return). Social Security is either not taxed at all, taxed at 50% or taxed at 85%, depending on your other income.

Also keep in mind some of the income is out of your control – whether or not you want to, a portion of your 401k or IRA will be taxed to you every year starting at age 70 1/2. (There is talk of increasing that to age 72, but that law hasn’t passed yet as of the date of this post). Also, if you inherit an IRA, you are also required to be taxed on a portion of that every year REGARDLESS of your age.

If your taxable income (for a couple filing joint) is greater than $32,000, 50% of your Social Security above that amount is taxed. At $44,000 of income, 85% is taxed. The calculation is complicated; I suggest running a tax projection to get the exact figures if this is your situation. (Taxable “income” in this scenario means your adjusted gross income plus tax exempt interest income plus half of your Social Security benefits.)

Why would you want to take a 15% tax deduction when you will pay 25-30% on the back end? If you are able to empty your IRA by converting it to a Roth slowly over time before age 70 (ideal SS collection date), then this may make sense. However, in practice converting an IRA to a Roth will cost more than 15% in most cases.

This is why we rarely suggest contributing to a 401k if you are in the 15% tax bracket. Go Roth all the way – Roth IRA and/or Roth 401k, if available to you. If not, save in a taxable brokerage account.

Finding a fee-only financial advisor who can run these tax projections for you can be very valuable. A good CFP practitioner should provide much more advice than just investments. Taxes is only one area, but a very critical one. Make sure your advisor has a thorough understanding of income taxes!

How To Rent Your House to Your S-Corporation

It isn’t as easy as you think. Thanks to an arcane rule in the Internal Revenue Code, you cannot deduct your expenses when renting your house to your S-Corporation (Section 280A(c)(6), for those dedicated enough to wade through Code). This rule disallows deductions against rent by an employee to an employer.

You can, however, effectively rent your house to your S Coporation and deduct all expenses – but you have to follow certain rules.

Step 1 – Setup what’s known as an “Accountable Plan” – this must be a written document

Step 2 – Obtain/write a letter from the S Corporation to you as employee explaining why the home office is for the convenience of the employer

Step 3 – Make sure the space is exclusively and regularly used for your business

Step 4 – Submit monthly expense reports for actual home office expenses, such as proportionate real estate taxes, homeowners insurance, mortgage interest, general repairs and maintenance, utilities and depreciation. (Make sure you allocate these based on the square footage of the space or some other reasonable method. Also make sure you do not depreciate the land portion of your house purchase cost).

Reimbursements of legitimate business expenses are not taxable to you, and are fully deductible by your S Corporation. Make sure you keep copies of the documentation proving your expenses (utility bills, for example).

Jumping through all these hoops may not be easy, but it can result in a huge tax savings! As a bonus, none of this is reported separately on Form 1099 or Schedule E. The rent expense is simply deducted by the S Corporation, and there is no required separate reporting for employee reimbursements.

Bottom line is that taxes are complicated, and you should not take tax advice from the internet! Discuss all this with your tax accountant to see if it applies to you.

SECURE Act – The Death of Never Pay Taxes Strategy?

Great article on the SECURE act, written by Nick Prigitano, CFP of Milestone Financial Planning, LLC! Will comment more when the act becomes law and we know the final provisions. It may change how much the FI community wants to save in pre-tax money (pre-tax IRAs and 401ks are already future tax bombs – for interesting reading on this visit the Wealthy Accountant). It may also kill a lot of “pay no taxes ever” strategies.

VTSAX: The best mutual fund?

There is a reason the SEC does not like it when investment advisors talk about specific investments. It is very easy to compare an apple to an orange, or otherwise promote misleading information about specific investments. In addition, everyone’s situation is different, and you should not be taking investment advice from the internet!!!!

I would like to focus on one common piece of advice I see in the FI community: investing in VTSAX.

I have heard a lot of talk about putting most of your investment dollars into VTSAX and then ignoring it. Having lived through the Great Recession as a fee-only planner and investment advisor, I’m not sure most people can do this.

Let’s say you had a portfolio of $10,000 invested in VTSAX on July 6, 2007 – 269.69 shares (it was trading at $37.08). By February 1, 2008 it was trading at 33.69 so your portfolio was worth $9,085.

Prices only dropped about 10% through September – the September 5, 2008 price was 30.46, or $8,215 portfolio value.

Then things really got crazy.

October 17, 2008: $22.75 per share. $6,135 portfolio value. Ouch. That’s almost a 40% loss in 15 months.

By December 31, 2008 the fund closed at $17.80/share, for a portfolio value of $4,800, or a loss of 52%. Are you still invested? The carnage isn’t over.

February 23, 2009 – closing price $14.75, or a portfolio value of $3,977. Portfolio loss of 61%. Now are you still invested?

Finally, March 9, 2009. Closing price $13.42/share. Portfolio value $3,619. Total “loss” in the period 63.8%. If you had $1M, it has declined to $361,900; even more if you were taking withdrawals. Good luck “going back to work” in 2009, when the unemployment rate was double digits.

The advantage of a good financial advisor is that they were counseling their clients to sit tight, not look at statements, believe in diversification and REBALANCE – sell bonds and buy stocks.

High-quality bond portfolios reduced this portfolio volatility, but there were still significant declines. In addition, woe to those who owned junk bond or many corporate bond funds – some of those had losses of 20% or more!

Having lived that on a daily basis as a financial advisor, I doubt very much that the average person on their way to FI is going to be able to stomach that and persevere all the way through, no matter how much Jim Collins NH they have read. Human behavior is what it is, and makes us all do stupid things.

It is critical to remember that past performance does not predict future results!!! Note that the above analysis does not include dividends, trading fees, taxes etc. – it is a price only analysis. Actual portfolio results would have varied. (Prices from Yahoo Finance).

Of course, today (June 18, 2019) VTSAX is trading at $72.41, so the original $10,000 portfolio of 269.69 shares is now worth $19,528 – if the owner was able to stay the course, and if they haven’t taken any withdrawals or paid any fees. There has been more volatility (ups and downs) since 2009, but 2008-2009 is the worst I have seen in my career. Also, not only were prices down, but stock mutual fund outflows were also rampant. Are you going to be able to resist the masses and stay invested in that environment?

If your advisor was able to talk you out of selling when your investment was, say, $5,000 they would have saved you much more than the difference between that and any recovered price. Those that sold in 2009 often never got back in, and suffered a permanent reduction in both their invested capital and standard of living.

A good financial advisor is worth many multiples of their fee.

Disclosure: The information contained above is for illustrative purposes only. The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.

All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.

Past performance is not indicative of future results! All price data is from Yahoo Finance VTSAX price history.

Jennifer Climo is a founder and senior advisor for Milestone Financial Planning, LLC, a fee-only financial planning firm. Jen is a CFP(R) practitioner, a CPA and has her Masters in Financial Planning. She has been working with individuals and small businesses since 1991.

Can I Skip Life Insurance (on the FI Path)

The point of life insurance is to protect your loved ones in case something happens to you. If you were to unexpectedly die, could your family still pay their bills without derailing your goals?

The majority of people only need term life insurance. (There are circumstances where whole life or universal can be applicable, but they are few and far between). If you are on the path to FI, and will accumulate, say, $1 million between now and when you “retire” in 7-10 years, you could buy a 10-year, $1 million policy. If you are young and healthy, it will be super cheap.

If you have already reached FI, then maybe you don’t need life insurance at all. However, I have never had a widow tell me their spouse had too much life insurance. When the main breadwinner dies, their spouse is almost always concerned about whether or not they can keep the house; keep paying for their expenses and continue their standard of living.

Term life insurance is so cheap, that if you have young children and are young and healthy, I would suggest a 20-year term policy. This gives your family a little more “protection” if something were to happen to you. One thing I have learned in life and in my business providing financial planning to individuals is that life often does not take the straight line we expect.

Owning a higher amount of life insurance for longer protects your family in the event of unexpected circumstances.

I personally bought a 30-year policy when my youngest was a baby. I wanted to cover costs through college for my children and a for my working life for my spouse (at the time), and the premiums were very cheap for the coverage that I received. If I were to buy any kind of policy now, only 8 years later, it would be more expensive due to my age and health changes.

The amount (or face value) of insurance you should have depends on your personal circumstances. I strongly suggest you work with an independent, fee-only financial advisor to determine the amount of coverage necessary and then a licensed insurance agent to place the coverage.

I have seen some people use the cheapest internet coverage they could find. This can be a problem if you have any kind of health condition, because some companies will provide cheaper life insurance premiums for certain health conditions. Also, some companies will deny you altogether for certain conditions, and once you have an insurance denial on your record it is very difficult to get insurance from anyone.

Those of us in FI don’t like to spend money unnecessarily. However, life insurance is a risk where the consequences of a negative outcome (your premature death) could be catastrophic compared to the relatively small cost when you are young.