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Investing Blog Roundup: How to Make Your 401(k) Pay as Much as a Pension

In the realm of personal finance, far too much attention is paid to investing — with the implicit idea that if you find just the right mutual funds, just the right asset allocation, and just the right plan for rebalancing, you’ll be sure to meet your goals.

In reality, none of those things matter very much, unless you have a sufficiently high savings rate (or, in the case of a retiree, a sufficiently low spending rate).

Recommended Reading

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New Book: Corporate Finance Made Simple

I have a new book, out this week: Corporate Finance Made Simple (print version, Kindle version).

As you can tell from the name, the book is primarily focused on finance in a business context, but, in writing it, I chose to give particular emphasis to topics that play important roles in personal finance as well (e.g., the concept of net present value).

Also, while corporate finance naturally focuses on corporations, many of the concepts still apply to other types of businesses, such as partnerships or LLCs.

What is Corporate Finance, and Why Should You Care?

Corporate finance is primarily concerned with two broad topics: how businesses access capital (i.e., money) to fund their operations and how businesses choose to use the capital that they have.

There are two basic ways in which a business can raise capital: it can borrow money (including by issuing bonds), or the existing owners can sell a share of the business (i.e., issue stock). Part 1 of the book discusses the pros and cons of each option — and how businesses find a balance between the two.

Part 2 discusses capital budgeting, which is the process of evaluating potential projects or investments (i.e., potential ways in which a business can use its limited capital).

Part 3 discusses valuation of the two most fundamental financial instruments: stocks and bonds. Note that this is closely related to the topics from Part 1, except that now we’re looking from the perspective of the investor (i.e., the party providing the capital).

In other words, in this book you’ll learn things such as:

  • What stock and bond prices actually represent — and why they behave the way they do;
  • Why some profitable corporations pay dividends, while others do not;
  • Techniques that can be useful for your own financial planning (for instance, an understanding of present value is critical to doing any sort of Social Security analysis).

What’s the Difference between Finance and Accounting?

The purpose of accounting is largely to provide internal and external users with financial information about a business (e.g., financial statements). Finance is one field that uses that information. A business’s finance professionals are constantly looking at the business’s own financial information to make decisions such as whether to pay a dividend to shareholders, whether to pay down debt, whether to borrow more money, and so on. And in many cases financial professionals will look at financial statements of other businesses as well (e.g., to evaluate whether their firm should acquire the other business).

One difference between accounting and finance is that accounting is primarily concerned with recording and reporting events that have already happened, whereas finance is primarily concerned with making projections and plans about the future.

Another key distinction between accounting and finance is that, in finance, we are not required to follow any specific set of official rules (such as Generally Accepted Accounting Principles or International Financial Reporting Standards that must be followed in accounting). We are instead free to use whatever calculation methods we want, in order to get the necessary information to make the decisions we have to make.

If this sounds interesting to you, I’d encourage you to buy a copy: Corporate Finance Made Simple.

For those curious, the full table of contents is as follows:

Part One: Raising Capital

1. Raising Capital by Borrowing

  • Bank loans
  • Bonds
  • Bond terminology
  • Cost of borrowing
  • Risk of borrowing

2. Raising Capital by Selling Equity

  • Common stock
  • Shareholder rights
  • Cost of equity
  • Preferred stock
  • Private placements & venture capital
  • Going public
  • Primary and secondary markets

3. Dividend Policy

  • Retained earnings are a source of capital
  • Dividend dates
  • Stock repurchases

4. Capital Structure

  • Debt-to-equity ratio
  • Risk
  • Cost of capital
  • Calculating weighted average cost of capital

Part Two: Deploying Capital: Capital Budgeting

5. Evaluating a Project: Forecasting Cash Flow

  • Which cash flows are relevant?
  • After-tax cash flows

6. Time Value of Money: Discounted Cash Flow

  • Future value
  • Present value
  • Discount rates
  • Key present value takeaways

7. Net Present Value

  • Making decisions based on NPV
  • Discount rate and risk level
  • WACC as a discount rate

8. Other Capital Budgeting Methods

  • Internal rate of return (IRR)
  • Payback period
  • Discounted payback period
  • Profitability index

Part Three: The Investor’s Perspective

9. Bond Valuation

  • Just an NPV calculation
  • Current yield and yield to maturity
  • Credit risk premium
  • Bond pricing
  • Maturity risk premium
  • Yield curves

10. Stock Valuation

  • Dividend discount model
  • Earnings-based valuation
  • Asset-based valuation
  • Capital asset pricing model (CAPM)

11. Efficient Markets

  • Price changes and new information
  • Stock market efficiency
  • Expectations are “priced in”

Conclusion: Accessing and Deploying Capital

Appendix: Financial Ratios

Take a look on Amazon: Corporate Finance Made Simple.

To Learn More, Check Out the Book:

Corporate Finance Made Simple: Corporate Finance Explained in 100 Pages or Less

Topics Covered in the Book:
  • The difference between finance and accounting
  • Raising capital by borrowing or by selling equity
  • Cost of capital
  • Net present value, IRR, and other capital budgeting metrics
  • Click here to see the full list.

Investing Blog Roundup: Portfolio Makeovers

If you’ve hung out on the Bogleheads forum very much, you’ve surely seen plenty of discussions in which a person comes in with a mess of a portfolio and forum members provide suggestions for how to clean it up: changes that would improve diversification, reduce costs, simplify, etc.

This week Morningstar is publishing a similar series from Christine Benz — providing portfolio makeovers for people in a range of circumstances.

Recommended Reading

Thanks for reading!

2021 Tax Brackets, Standard Deduction, and Other Changes

The IRS recently published the annual inflation updates for 2021. If you have questions about a particular amount that I do not mention here, you can likely find it in the official IRS announcements:

Single 2021 Tax Brackets

Taxable Income
Tax Bracket:
$0-$9,950 10%
$9,950-$40,525 12%
$40,525-$86,375 22%
$86,375-$164,925 24%
$164,925-$209,425 32%
$209,425-$523,600 35%
$523,600+ 37%

 

Married Filing Jointly 2021 Tax Brackets

Taxable Income
Tax Bracket:
$0-$19,900 10%
$19,900-$81,050 12%
$81,050-$172,750 22%
$172,750-$329,850 24%
$329,850-$418,850 32%
$418,850-$628,300 35%
$628,300+ 37%

 

Head of Household 2021 Tax Brackets

Taxable Income
Tax Bracket:
$0-$14,200 10%
$14,200-$54,200 12%
$54,200-$86,350 22%
$86,350-$164,900 24%
$164,900-$209,400 32%
$209,400-$523,600 35%
$523,600+ 37%

 

Married Filing Separately 2021 Tax Brackets

Taxable Income
Marginal Tax Rate:
$0-$9,950 10%
$9,950-$40,525 12%
$40,525-$86,375 22%
$86,375-$164,925 24%
$164,925-$209,425 32%
$209,425-$314,150 35%
$314,150+ 37%

 

Standard Deduction Amounts

The 2021 standard deduction amounts are as follows:

  • Single or married filing separately: $12,550
  • Married filing jointly: $25,100
  • Head of household: $18,800

The additional standard deduction for people who have reached age 65 (or who are blind) is $1,350 for each married taxpayer or $1,700 for unmarried taxpayers.

IRA Contribution Limits

The contribution limit for Roth IRA and traditional IRA accounts is unchanged at $6,000.

The catch-up contribution limit for people age 50 or over does not get inflation adjustments and therefore is still $1,000.

401(k), 403(b), 457(b) Contribution Limits

The salary deferral limit for 401(k) and other similar plans is unchanged at $19,500.

The catch-up contribution limit for 401(k) and other similar plans for people age 50 and over is unchanged at $6,500.

The maximum possible contribution for defined contribution plans (e.g., for a self-employed person with a sufficiently high income contributing to a solo 401(k)) is increased to $58,000.

Child Tax Credit

The child tax credit ($2,000 per child) and the related phaseout threshold ($200,000 of modified adjusted gross income, $400,000 if married filing jointly) do not get inflation adjustments. The portion of the credit that can be refundable (up to $1,400 per child) does receive inflation adjustments, but it is still $1,400 for 2021.

Capital Gains and Qualified Dividends

For 2021, long-term capital gains and qualified dividends face the following tax rates:

  • 0% tax rate if they fall below $80,800 of taxable income if married filing jointly, $54,100 if head of household, or $40,400 if filing as single or married filing separately.
  • 15% tax rate if they fall above the 0% threshold but below $501,600 if married filing jointly, $473,750 if head of household, $445,850 if single, or $250,800 if married filing separately.
  • 20% tax rate if they fall above the 15% threshold.

Alternative Minimum Tax (AMT)

The AMT exemption amount is increased to:

  • $73,600 for single people and people filing as head of household,
  • $114,600 for married people filing jointly, and
  • $57,300 for married people filing separately.

Estate Tax

The estate tax exclusion is increased to $11,700,000 per decedent.

Pass-Through Business Income

With respect to the 20% deduction for qualified pass-through income, for 2021, the threshold amount at which the “specified service trade or business” phaseout and the wage (or wage+property) limitations begin to kick in will be $329,800 for married taxpayers filing jointly, $164,900 for single taxpayers and people filing as head of household, or $164,925 for married people filing separately.

For More Information, See My Related Book:

Book3Cover

Taxes Made Simple: Income Taxes Explained in 100 Pages or Less

Topics Covered in the Book:
  • The difference between deductions and credits,
  • Itemized deductions vs. the standard deduction,
  • Several money-saving deductions and credits and how to make sure you qualify for them,
  • Click here to see the full list.

A testimonial from a reader on Amazon:

"Very easy to read and is a perfect introduction for learning how to do your own taxes. Mike Piper does an excellent job of demystifying complex tax sections and he presents them in an enjoyable and easy to understand way. Highly recommended!"

Investing Blog Roundup: Social Security — Becoming a Near-Term Problem

It’s no secret that Social Security is insufficiently funded. For as long as I’ve been dealing with personal finance, the Trustees (of the Old-Age and Survivors Insurance Trust Fund) have been putting out an annual report that the fund is expected to deplete somewhere around 2033, give or take a couple of years.

As Tara Siegel Bernard notes this week, the pandemic will have a negative effect on that projection as well, due to the reduced tax revenue this year (if a person is out of work, they aren’t paying payroll tax). The sooner we enact a solution, the less drastic the solution will have to be.

Other Recommended Reading

Thanks for reading!

What is a Rollover IRA? (Rollover IRA vs. Traditional IRA)

A reader writes in, asking:

“At my primary brokerage firm I have two IRAs: a traditional IRA and a rollover IRA that holds assets that came from my prior employer’s 401-k plan. What is the difference between the two?”

“Rollover IRA” is just a subcategory of “traditional IRA.” In other words, a rollover IRA is a traditional IRA. Specifically, rollover IRAs are traditional IRAs that contain nothing but assets that came from an employer-sponsored plan.

Because a rollover IRA is a traditional IRA, it gets all the same tax treatment as a normal traditional IRA. That is, distributions from the account are generally taxable; you can do a Roth conversion of the assets in the account; it’s treated the same way with regard to aggregation rules as other traditional IRAs; and so on.

Rollover IRAs are designated as such (rather than just being called regular traditional IRAs) for two reasons.

Reason #1: some employer plans only accept rollovers from an IRA when the IRA contains only assets from another employer-sponsored plan. So keeping those assets separate in their own IRA (rather than combining them with other assets in a traditional IRA) could preserve your ability to roll those assets into a different employer plan at a later date. But fewer and fewer employer plans have this policy every year, so this distinction is becoming less relevant.

Reason #2: assets in an employer-sponsored plan have unlimited creditor protection in bankruptcy under federal law. In contrast, IRA assets are only protected up to a certain limit ($1,362,800 as of 2020). If assets from an employer-sponsored plan are rolled into an IRA and kept separate (i.e., kept in a separate “rollover IRA”), they continue to receive that unlimited protection. If the assets get commingled with other assets in a traditional IRA, then they might lose that unlimited protection and “only” be protected up to the $1,362,800 limit.

That said, some people make the case that if you have good records and could prove that the assets in question came from an employer plan, you would still have unlimited protection for those assets. Also, many states provide additional protection to IRA assets beyond what federal law provides. And of course most people’s IRA assets are never going to exceed the federal protection limit anyway.

To summarize, a rollover IRA is a traditional IRA and is taxed as such, but there are two reasons for keeping rollover IRA assets separate from other traditional IRA assets. It may well be the case, however, that neither of those two reasons is particularly applicable to your own circumstances.

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