Archives for November 2021

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Investing Blog Roundup: Tax Provisions in the Build Back Better Act

I hope you enjoyed the Thanksgiving holiday.

The House recently passed the Build Back Better Act, which includes a range of individual income tax changes. It is not, however, a sure bet that the same will actually pass in the Senate and become law.

As far as the version passed in the House, it does include a provision that prohibits Roth conversions of after-tax amounts after 2021, which would effectively end “backdoor” Roth strategies.

Recommended Reading

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International Allocation: Maximum and Minimum

What percentage of the stock portion of your portfolio should be invested internationally? Vanguard’s website (in a section only accessible if you’re logged in) contains this statement:

“Investing up to 20% of your stock portfolio in international stocks can help you diversify. Between 20% and 40%, your diversification improves, but at a lower rate. And because of the risks of international investing, an upper limit of 40% is wise.”

20-40%. That’s more or less in keeping with conventional wisdom.

But conventional wisdom seems to gloss over something here: Having 80% of your portfolio (more than 80% if we assume that the entire bond portion is invested in U.S. bonds) invested in one country is not diversified–especially for anybody whose income is largely dependent upon the U.S. economy.

Past and Future

I assume Vanguard’s statement is based on an analysis of historical returns. I can only guess which exact period(s) they’re looking at, but surely it’s limited to the 20th century plus the first decade of this century–a period during which the United States went from being a young upstart nation to being the world’s largest economic superpower.

It’s hardly a surprise that based on an analysis of that period, a U.S.-heavy portfolio looks pretty darned good. What I’m not so sure we can expect is for the next 10, 20, 30, or 60 years to look the same.

Starting Point: Market-Weighted Portfolio

To me, it seems that the starting point for discussion should be a market-weighted portfolio. At the moment, such a portfolio would be invested approximately 60% in the U.S. and 40% internationally.

From there, you can make adjustments to cater to your specific needs. For example, if you’re in (or close to) retirement, it could makes sense to decrease your international allocation for two reasons:

  • First, you’re going to be spending down your investments soon, which means that it would be good to minimize currency risk (the risk caused by fluctuations in exchange rates that comes with owning non-U.S. investments).
  • Second, you have fewer years remaining in the workforce, meaning that you’re less dependent upon the U.S. economy that somebody who is, say, 25 or 30.

Avoiding the “Growth Trap”

What I’d caution against, however, is falling into the growth trap–overweighting emerging markets (China or India, for instance) simply because you know they’re going to grow at a faster rate than the U.S. over the next couple decades.

When it’s obvious that a country’s economy will be growing quickly, that growth should already be reflected in the price of their stocks. To earn above-market returns, you need to invest not in countries (or companies) that grow quickly, but in countries (or companies) that grow more quickly than expected.

If you’re going to invest more of your portfolio in non-U.S. investments than conventional wisdom would suggest, do it with the goal of diversification, not with the goal of earning superstar returns.

Qualified Charitable Distributions (QCDs): How do they work, and are they the best option for charitable giving?

The following is an excerpt from my book More Than Enough: A Brief Guide to the Questions That Arise After Realizing You Have More Than You Need.

A qualified charitable distribution (QCD) is a distribution from a traditional IRA directly to a charitable organization (i.e., the check is made out directly to the organization rather than to you). Unlike most distributions from a traditional IRA, QCDs are not taxable as income. And QCDs count toward your required minimum distribution for the year in which you take the QCD. QCDs are limited to $100,000/year — per spouse, if you’re married. (Beginning in 2024, this $100,000 limit will receive annual inflation adjustments.)

To qualify for qualified charitable distributions you must be at least age 70.5. (Yes, it really is age 70.5. The legislation that increased the age for RMDs did not change the age for QCDs.)

Qualified charitable distributions work on a calendar year basis. That is, there’s no “I’m doing this in March of 2024, and I want it to count for 2023” option as there is for contributions to an IRA.

Another important point about qualified charitable distributions is that they cannot be taken from an employer-sponsored plan such as a 401(k) or 403(b). They must come specifically from traditional IRAs. (This can be a point in favor of rolling assets from an employer-sponsored plan to a traditional IRA.)

Qualified charitable distributions are generally more tax-efficient than taking a normal distri­bution, having it included in your taxable income, and then donating the money. In that second case (taking a taxable distribution, then donating the money), you get an itemized deduction. With a QCD, the donated amount is completely excluded from income which means you can still use the standard deduction in the year in question and still receive a tax benefit from your charitable giving. It also means that your adjusted gross income (AGI) is lower, which can result in other tax savings, because various other deductions and credits are based on your level of AGI.

One final note about QCD rules: a donor-advised fund cannot be the recipient of a qualified charitable distribution.

QCDs vs. Donating Appreciated Taxable Assets

When you donate taxable assets (i.e., assets that are not in any account with special tax treatment such as an IRA) that have gone up in value and that you have owned for longer than one year, you get to claim an itemized deduction for the current market value of the asset and you do not have to pay tax on the appreciation.

EXAMPLE: Carmen owns shares of stock that she purchased 18 months ago for a total of $19,000. The shares are currently worth $25,000. If she donates them, she will receive an itemized deduction for their fair market value ($25,000).

In other words, when donating appreciated taxable assets that you have held for longer than one year, there are two potential sources of tax savings. Firstly, you get an itemized deduction for the donation. And secondly, you do not have to pay tax on the appreciation.

When choosing between qualified charitable distributions or donating taxable assets, one advantage of QCDs is that you can take advantage of them while claiming the standard deduction. In contrast, donations from taxable assets (including regular checking account dollars) give you an itemized deduction. And itemized deductions are only valuable to the extent that they (in total) exceed the standard deduction for the year.

QCDs also have the advantage that they reduce your adjusted gross income, which can sometimes produce additional beneficial results, such as allowing you to qualify for another deduction or credit or bringing your income below a particular threshold for determining Medicare premiums. In contrast, the itemized deduction from donating taxable assets does not reduce your AGI and therefore will not produce any such effects.

With regard to donating taxable assets, donating appreciated assets that you have owned for longer than one year is strictly better than donating other taxable account dollars (e.g., cash in a checking account), because you get to claim an itemized deduction for the current market value of the assets, while not having to pay tax on the appreciation.

To briefly summarize, the typical order of preference for donations each year is:

  1. Donating via QCDs (if you’re at least age 70.5),
  2. Donating appreciated taxable assets with a holding period longer than one year,
  3. Donating taxable account cash (e.g., checking/savings balances),
  4. Donating appreciated taxable assets that you have held for one year or less,
  5. Donating Roth IRA dollars (or donating traditional IRA dollars if you are younger than 70.5), and finally
  6. Donating taxable assets where the current market value is less than your cost basis. (This option is unwise because your deduction is limited to the market value, and you don’t get to claim a loss for the decline in value. Better to sell the asset, claim the capital loss, then donate the resulting cash.)

Simple Summary

  • A qualified charitable distribution is a distribution from a traditional IRA directly to a charitable organization (other than a donor-advised fund).
  • QCDs are excluded from your gross income, but they still count toward your required minimum distribution for the year in which you take the QCD.
  • QCDs are limited to $100,000 per year (per spouse, if you’re married). This $100,000 limit is scheduled to start receiving annual inflation adjustments beginning in 2024.
  • You must be at least age 70.5 in order to take a qualified charitable distribution.
  • For people with charitable intentions who don’t intend to spend their entire RMD in a given year and who are concerned about the tax bill they’ll face on their RMDs, qualified charitable distributions are an excellent solution. The overall result is that you were able to claim a deduction when you put the money into the account, the money grew tax-free over time while it remained in the account, and now it comes out tax-free as well.

What Comes After Financial Independence?

Among people who read personal finance books, many save a high percentage of their income through most of their careers. One thing that eventually happens for some such people is that they reach a point at which they realize they have not only saved "enough," they have saved "more than enough." Their desired standard of living in retirement is well secured, and it’s likely that a major part of the portfolio is eventually going to be left to loved ones and/or charity. And that realization raises a whole list of new questions and concerns.

This book’s goal is to help you answer those questions.

More than Enough: A Brief Guide to the Questions That Arise After Realizing You Have More Than You Need

Topics Covered in the Book:
  • Impactful charitable giving
  • Talking with your kids or other heirs
  • Qualified charitable distributions
  • Deduction bunching
  • Donor-advised funds
  • Trusts
  • Click here to see the full list.

2022 Tax Brackets, Standard Deduction, and Other Changes

The IRS recently published the annual inflation updates for 2022. 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 2022 Tax Brackets

Taxable Income
Tax Bracket:
$0-$10,275 10%
$10,275-$41,775 12%
$41,775-$89,075 22%
$89,075-$170,050 24%
$170,050-$215,950 32%
$215,950-$539,900 35%
$539,900+ 37%

 

Married Filing Jointly 2022 Tax Brackets

Taxable Income
Tax Bracket:
$0-$20,550 10%
$20,550-$83,550 12%
$83,550-$178,150 22%
$178,150-$340,100 24%
$340,100-$431,900 32%
$431,900-$647,850 35%
$647,850+ 37%

 

Head of Household 2022 Tax Brackets

Taxable Income
Tax Bracket:
$0-$14,650 10%
$14,650-$55,900 12%
$55,900-$89,050 22%
$89,050-$170,050 24%
$170,050-$215,950 32%
$215,950-$539,900 35%
$539,900+ 37%

 

Married Filing Separately 2022 Tax Brackets

Taxable Income
Marginal Tax Rate:
$0-$10,275 10%
$10,275-$41,775 12%
$41,775-$89,075 22%
$89,075-$170,050 24%
$170,050-$215,950 32%
$215,950-$323,925 35%
$323,925+ 37%

 

Standard Deduction Amounts

The 2022 standard deduction amounts are as follows:

  • Single or married filing separately: $12,950
  • Married filing jointly: $25,900
  • Head of household: $19,400

The additional standard deduction for people who have reached age 65 (or who are blind) is $1,400 for each married taxpayer or $1,750 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 increased from $19,500 to $20,500.

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 from $58,000 to $61,000.

Health Savings Account Contribution Limits

For 2022, the maximum HSA contribution for somebody with self-only coverage under a high deductible health plan is $3,650. The limit for somebody with family coverage under such a plan is $7,300.

The HSA catch-up contribution limit for people age 55 and over is not inflation adjusted, so it remains at $1,000.

Capital Gains and Qualified Dividends

For 2022, long-term capital gains and qualified dividends face the following tax rates:

  • 0% tax rate if they fall below $83,350 of taxable income if married filing jointly, $55,800 if head of household, or $41,675 if filing as single or married filing separately.
  • 15% tax rate if they fall above the 0% threshold but below $517,200 if married filing jointly, $488,500 if head of household, $459,750 if single, or $258,600 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:

  • $75,900 for single people and people filing as head of household,
  • $118,100 for married people filing jointly, and
  • $59,050 for married people filing separately.

Annual Gift Tax Exclusion

For 2022 the annual exclusion for gifts has increased from $15,000 to $16,000.

Estate Tax

The estate tax exclusion is increased to $12,060,000 per decedent.

Pass-Through Business Income

With respect to the 20% deduction for qualified pass-through income, for 2022, 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 $340,100 for married taxpayers filing jointly and $170,050 for single taxpayers, people filing as head of household, and 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!"

Medicare IRMAA Appeal (a.k.a. Request for Reconsideration)

In general, once you become eligible for Medicare (either by reaching age 65 or by being on Social Security disability for two years), your Medicare premiums for a given year are based on your modified adjusted gross income (MAGI*) from two years prior. For example, a person’s 2022 premiums are based on their 2020 income level.

The law is written this way for a simple pragmatic reason: “two years ago” is generally the most recent data Medicare has at the time they must determine your premium for a given year. For example, a person’s 2022 Medicare premiums must be determined in 2021 — at which point Medicare doesn’t have the person’s 2021 information yet, so they use 2020.

However, the law also provides that, if your income declines significantly from one year to the next due to a “life changing event” you may request that your premiums be based on that more recent year’s level of income, rather than your income from two years ago. This request may be referred to as a “request for reconsideration”, “Medicare Part B premium appeal”, or “Medicare IRMAA appeal.” Life changing events include:

  • Marriage,
  • Divorce/annulment,
  • Death of a spouse,
  • You or your spouse stopped working or reduced the hours that you work,
  • You or your spouse experienced a loss of income-producing property that was not at your direction (i.e., you did not intentionally sell the property), or
  • You or your spouse experienced a cessation, termination, or reorganization of an employer’s pension plan.

Filing Form SSA-44 is how you make such a request for reconsideration.

Why Is This Important?

In short, this is most likely to be important for:

  • High earners who retire in a year they (or their spouse) turn 63 or older or
  • High earners who retire when their spouse is receiving Social Security disability benefits.

Consider this example: Amanda and Neil collectively earn about $250,000 per year. They both retire in June of 2022, at age 64, after having earned roughly $120,000 for the year. When they begin Medicare at age 65 in 2023, their premiums will initially be based on their 2021 level of income ($250,000), which puts them in the third Medicare IRMAA tier.

They can, however, file an IRMAA appeal and request that their premiums instead be based on their 2022 income level. The net result is that they save $180.30, per month, per person in Medicare Part B and D premiums by filing Form SSA-44.

*For Medicare IRMAA purposes, MAGI is calculated as your adjusted gross income, plus tax-exempt interest, plus any foreign earned income or income from US territories that was excluded from your gross income.

Retiring Soon? Pick Up a Copy of My Book:

Can I Retire Cover

Can I Retire? Managing a Retirement Portfolio Explained in 100 Pages or Less

Topics Covered in the Book:
  • How to calculate how much you’ll need saved before you can retire,
  • How to minimize the risk of outliving your money,
  • How to choose which accounts (Roth vs. traditional IRA vs. taxable) to withdraw from each year,
  • Click here to see the full list.

A Testimonial from a Reader on Amazon:

"Hands down the best overview of what it takes to truly retire that I've ever read. In jargon free English, this gem of a book nails the key issues."
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