Archives for December 2017

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Investing Blog Roundup: Happy Holidays

Administrative note: There will be no articles this upcoming week. The normal publishing schedule will resume on January 1. Happy Holidays and Happy New Year to all of you!

Both the House and Senate have now passed identical bills regarding the new tax law. Relative to the version that came out last Friday night (which we discussed on Monday), the only difference that could affect personal financial planning is that the expanded definition of qualified distributions from 529 accounts will not include homeschooling expenses.

Other Money-Related Articles

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2018 Tax Brackets, Standard Deduction, and Other Changes

We now have the final text of the new tax law. Please note, however, that the Act is long (just over 500 pages) and complicated. Point being: there are many changes that I have not included in this article. My goal here is just to mention some of the changes that are most likely to affect a large number of readers.

Also, many of the changes below have built-in expiration dates (e.g., the new tax bracket system is supposed to last through 2025). However, I have omitted such expiration dates below because they’re several years in the future, and it’s anybody’s guess whether such expiration will actually be allowed to occur. That is, Congress may decide to temporarily renew the changes at some point, may make them permanent, or may repeal them prior to their expiration dates.

Single 2018 Tax Brackets

Taxable Income
Tax Bracket:
$0-$9,525 10%
$9,526-$38,700 12%
$38,701-$82,500 22%
$82,501-$157,500 24%
$157,501-$200,000 32%
$200,001-$500,000 35%
$500,001+ 37%

 

Married Filing Jointly 2018 Tax Brackets

Taxable Income
Tax Bracket:
$0-$19,050 10%
$19,051-$77,400 12%
$77,401-$165,000 22%
$165,001-$315,000 24%
$315,001-$400,000 32%
$400,001-$600,000 35%
$600,001+ 37%

 

Head of Household 2018 Tax Brackets

Taxable Income
Tax Bracket:
$0-$13,600 10%
$13,601-$51,800 12%
$51,801-$82,500 22%
$82,501-$157,500 24%
$157,501-$200,000 32%
$200,001-$500,000 35%
$500,001+ 37%

 

Married Filing Separately 2018 Tax Brackets

Taxable Income
Marginal Tax Rate:
$0-$9,525 10%
$9,526-$38,700 12%
$38,701-$82,500 22%
$82,501-$157,500 24%
$157,501-$200,000 32%
$200,001-$300,000 35%
$300,001+ 37%

 

Standard Deduction Amounts

The 2018 standard deduction amounts will be as follows:

  • Single or married filing separately: $12,000
  • Married filing jointly: $24,000
  • Head of household: $18,000

The additional standard deduction for people who have reached age 65 (or who are blind) is $1,300 for each married taxpayer or $1,600 for unmarried taxpayers.

Personal exemptions and dependent exemptions will no longer exist.

Child Tax Credit

The child tax credit is increased from $1,000 per child to $2,000 per child, with the phaseout range not beginning until $200,000 of modified adjusted gross income ($400,000 if married filing jointly). Up to $1,400 of the credit (per child) will be refundable.

Changes to Itemized Deductions

Firstly, with regard to mortgages and home equity loans, only interest related to “acquisition indebtedness” will be deductible. This includes debt related to “acquiring, constructing, or substantially improving” your qualified residence. In other words, the interest on many home equity loans will no longer be deductible.

In addition, for “acquisition indebtedness” taken out 12/16/2017 or later, only interest on the first $750,000 of the balance ($375,000 if married filing separately) will be deductible. For loans taken out on or before 12/15/2017, the old $1,000,000 limit ($500,000 if married filing separately) will apply.

The deduction for state/local/foreign property taxes and income taxes remains in place, as well as the option to deduct state and local sales taxes instead of state and local income taxes in any year. The total deduction, however, will be limited to $10,000 per year ($5,000 if married filing separately).

The deduction for medical expenses will still exist. And for 2017 and 2018, the threshold for deductibility will be 7.5% of adjusted gross income rather than 10%.

Personal casualty losses (e.g., losses due to fire, storm, theft) will no longer be deductible unless they are attributed to a federally declared disaster.

Capital Gains and Qualified Dividends

Long-term capital gains and qualified dividends will still have 0%, 15%, and 20% tax rates. The income thresholds separating those different tax rates, however, have changed. For 2018, long-term capital gains and qualified dividends will face the following tax rates:

  • 0% tax rate if they fall below $77,200 of taxable income if married filing jointly, $51,700 if head of household, or $38,600 if filing as single or married filing separately.
  • 15% tax rate if they fall above the 0% threshold but below $479,000 if married filing jointly, $452,400 if head of household, $425,800 if single, or $239,500 if married filing separately.
  • 20% tax rate if they fall above the 15% threshold.

Note that threshold for the top of the 0% tax rate is close to but not the same as the top of the 12% tax bracket.

The 3.8% tax on net investment income that can apply if your modified adjusted gross income exceeds $200,000 ($250,000 if married filing jointly) is unchanged.

Chained CPI

Many amounts that were previously inflation-indexed to CPI-U will now be indexed to chained CPI-U going forward. (I’m not aware of anything that will remain indexed to CPI-U, but I have not done an exhaustive search to check.)

Alternative Minimum Tax (AMT)

The AMT exemption amount will be increased to:

  • $70,300 for single people and people filing as head of household,
  • $109,400 for married people filing jointly, and
  • $54,700 for married people filing separately.

Estate Tax

The estate tax exclusion is being increased to $11.2 million per decedent.

Expanded 529 Applicability

With regard to 529 accounts, qualified distributions have been expanded to include distributions for elementary/secondary public, private, or religious school.

Individual Mandate (2019)

Beginning in 2019, the individual mandate (i.e., the penalty for not having health insurance) will disappear.

Alimony Payments (2019)

For divorces that become finalized in 2019 or later, alimony payments will no longer be deductible to the payor, nor includable as income to the payee.

Pass-Through Business Income

For taxpayers with “pass-through business income” (i.e., income from a sole proprietorship, partnership, or S-corporation), there will be a deduction equal to 20% of such pass-through income. However, if your taxable income (without regard to this deduction) exceeds $157,500 ($315,000 if married filing jointly), several complicating factors can apply.

For instance, if your taxable income is above the threshold amount and your business is a “specified service trade or business” (i.e.,  your business provides services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or the principal asset of your business is the reputation or skill of 1 or more of its employees), your deduction will be reduced.

Or, if your taxable income is above the threshold amount, your deduction for pass-through income from the business may be limited based on your wages from the business (potentially being limited to 50% of such wages, if your taxable income is high enough).

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Investing Blog Roundup: Retirement Calculators for Android

As regular readers surely know, Darrow Kirkpatrick is one of my favorite personal finance writers.

In Darrow’s prior career, he was a software engineer. This week, he launched two new retirement calculators for Android. My wife and I are both iPhone users, so unfortunately I haven’t had a chance to try the calculators personally. But based on the videos explaining the calculators, I am impressed by how thorough they appear to be while still being easy to use/understand on a mobile device.

If you’re an Android user, I’d encourage you to check them out.

Other Money-Related Articles

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Financial Planning Priorities

A reader writes in, asking:

“I am getting my financial house in order for the first time. I have no debt and a good income, but have not paid much attention to investing until now. A friend directed me to your blog and to the bogleheads website, but I am finding it all to be overwhelming. Do you have any suggestions for which topics to read about/focus on first?”

The Bogleheads forum is filled with investing enthusiasts. As such, there are several advanced topics that get a lot of discussion there, which most people can safely ignore. For example:

  • Should you use international bonds?
  • Should you use “smart beta” funds?
  • Should you tilt toward small/value/momentum/profitability?
  • Should you include corporate bonds in the portfolio? A TIPS fund?
  • Should the bonds be short-term, intermediate-term, or long-term?
  • How often should you rebalance to your target allocation?

When getting started, most people should ignore all of the above topics and simply start with a “three fund portfolio,” or possibly even a low-cost “all-in-one fund” (e.g., a Vanguard Target Retirement fund).

In fact, most people should never spend any time thinking about the above topics, because:

  1. There’s a limited amount of time that they’re willing to devote to financial planning, and
  2. There are other financial planning topics that are much more important.

For example, all of the following financial planning to-do items are more important than the asset allocation questions listed above.*

  • Basic insurance planning (i.e., making sure you have appropriate health insurance, life insurance if anybody is dependent on you for income, disability insurance unless you’re retired, etc.)
  • Budgeting (i.e., selecting a spending/saving rate that’s appropriate relative to your income/assets)
  • Basic portfolio allocation (i.e., stock/bond allocation, as well as making sure there isn’t too much in one single stock)
  • Basic estate planning
  • Basic tax planning
  • Social Security planning (if near retirement)
  • Minimizing portfolio costs (i.e., making sure to use funds with low expense ratios)

It’s only after taking care of all of these items that it would make any sense to think about things like whether or not your portfolio should include “smart beta” mutual funds. And even for people who have taken care of these other financial planning to-do items, there’s still no need to spend time thinking about all of those advanced asset allocation questions. In nearly all cases, it’s perfectly fine to stick with that simple “three fund portfolio” — or even the single all-in-one fund in some cases.

*I’ve attempted to order this list roughly from highest to lowest priority. The exact order of priority will vary from one person to another though. For example, if you’re unmarried and have no kids, estate planning would be a lower priority than it would be for somebody with children. And estate planning would be an especially high priority for a married couple who each have children from a prior marriage.

Investing Blog Roundup: Planning for Tax Changes

While we still don’t know what the final law will look like, one thing that seems very likely is that many people who currently itemize will be claiming the standard deduction going forward (because many itemized deductions are likely to go away, while the standard deduction is likely to be increased considerably). As a result, one thing that likely makes sense for many people will be to accelerate itemized deductions, if possible.

The following article has more information. But again, it’s key to keep in mind that nothing is set in stone yet.

Other Money-Related Articles

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How Do Long-Term Care Annuities Work?

A reader writes in, asking:

“I do not have long term care insurance, and likely will not be able to buy any in the future due to a pre-existing medical condition. An acquaintance recently recommended that I consider purchasing a long term care annuity. I’ve been reading about them, but they appear to be complicated products. And I have learned the hard way that it’s wise to be skeptical of complicated insurance products. Could you shed some light on how they work, and perhaps some thoughts on whether they’re worth buying?”

Long-term care annuities are deferred annuities, in the sense that they have an accumulation stage and a distribution stage.

Background for readers who aren’t familiar with those concepts: With a deferred annuity, during the “accumulation stage” you have an account that grows at either a fixed rate of return (if you have a fixed annuity) or a variable rate of return (if you have a variable annuity). Then, if you want to, you can shift to the “distribution stage” (this is known as “annuitizing” the annuity). When you do so, you give up the account, and in exchange you get a guaranteed stream of income (e.g., a stream of income that is guaranteed to last for your life).

With a long-term care annuity, you purchase a rider that provides a degree of long-term care protection during the accumulation stage. Because this protection disappears when you shift to the distribution stage (i.e., when you “annuitize” the annuity), the typical plan when purchasing a long-term care annuity is actually to never annuitize it at all (i.e., to stay in the accumulation stage indefinitely).

The long-term care annuities I have looked at are either fixed or fixed-indexed annuities, meaning they provide a guaranteed rate of return during the accumulation stage. For the annuities I’ve looked at, a 1% guaranteed rate of return (or somewhere in that ballpark) was typical.

And you have to pay a cost for the long-term care rider. The cost is usually in the ballpark of 1% per year for somebody age 65 (higher if you’re older, lower if you’re younger).

When you consider the ~1% fixed rate of return together with the ~1% annual cost for the rider, we’re talking about a product that has roughly zero expected growth.

How Does the Long-Term Care Protection Work?

Firstly, it’s important to know that the details vary from one policy to another. But the general way the long-term care rider works is that, if you deplete your account value by paying for long-term care over a specified period of time, you get access to some additional funds that you can spend on long-term care over another specified period of time.

For example, a policy may require that you spend down your account value over two years by paying for long-term care. And if you do so, then an additional sum of assets (which would be a specified amount, such as 2x your account value as of the date that you started needing long-term care) would be released to you to spend on long-term care over another period (e.g., four years).

So with such a policy, you would get no benefit from the rider at all if you need less than two years of long-term care (because during the first two years of care you’re just spending your own assets). And you would only get the full benefit from the rider if you need at least six years of long-term care.

Are Long-Term Care Annuities a Good Idea?

Whether or not you should buy a long-term care annuity depends on your circumstances.

First and most obviously: the more likely you are to need long-term care (and, specifically, a long period of long-term care), the more valuable a long-term care annuity might be.

Then there’s the question of your assets. If you have enough assets that you could pay out of pocket for long-term care without too much of a challenge, it’s usually undesirable to buy insurance against LTC risk (because, on average, insurance is a losing proposition for the purchaser, given that the insurance company prices it so that it will be profitable to them).

And on the other side of the spectrum, if your assets are low enough that Medicaid would kick in after just a couple years of long-term care, it’s probably not a good idea to buy insurance against LTC risk, because doing so isn’t protecting you from financial risk so much as protecting the government against financial risk.

In other words, it’s people in the middle asset range who are more likely to benefit from insuring against LTC risk (either through buying traditional LTC insurance or a long-term care annuity).

One potentially important point regarding LTC annuities is that they often have less thorough underwriting than regular LTC insurance. That is, a person who wouldn’t qualify for regular LTC insurance due to a medical condition might be able to qualify for a LTC annuity.

Another difference relative to traditional LTC insurance is that long-term care annuities (or life insurance products with LTC riders) can work as a sort of “high deductible” LTC policy, in that they don’t start paying until you’ve needed years of long-term care.

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