Cheese sticks and Capital Gains

Almost any personal asset that you own has a cost associated with it.  Typically, this is the amount you pay the cashier while they silently judge you for your obsession with mozzarella sticks.  In the case of more durable objects, there is the potential that someone in the future might pay you more than your purchase price to take them off your hands, provided they weren’t put in the air fryer for six minutes. The most common examples are stocks, bonds, and real estate, but can include goods ranging from cars to stamps.  The amount you paid for the asset is the basis, which is typically static but can be adjusted by things like improvements or depreciation.  When the asset is sold, you subtract the basis from the sale price to come up with the capital gain. How that capital gain is taxed by the IRS is dependent on two things. The first is how long you owned the asset in question.  If you held it for a year or more, you’re going to pay long-term capital gains tax, which is a preferential rate.  If you held it for a less than a year, you’re going to pay ordinary income tax, just like you would on any wages, pension, or IRA income. The second factor is your adjusted gross income, and to explain how that works we need to briefly explain how tax brackets work.  Tax brackets are kind of like a row of buckets.  Any income you receive in a year goes into the buckets in order; first the 10% bucket, then the 12% bucket, and so on.  You have to fill up each bucket before income “spills over” into the next one.  You pay the 10% rate on the amount in the 10% bucket, and pay the 12% rate only on the income in the 12% bucket.  In no case does earning extra income cause all of your… | Read More »

An apples to apples explanation of taxes

Ah, spring.  Can you feel it?  The sweet chorus of chickadees chirping; “Sun’s up in an hour. Hey. HEY! Fifty-nine minutes now.”  The gentle tingle of an afternoon breeze radiating warmth, hope, and the seeds of renew…ah-Choo! Can you ah pass ah me Choo…a Kleenex?   The mysterious migration from glen to glen of the species taxicus collecticus signaling subtly, almost imperceptibly that: “You can use Form 1040A if your income is only from wages, salaries, tips, interest, ordinary dividends, capital gain distributions, pensions, annuities, IRAs…” Hey!  Stay with me. Taxes aren’t as simple as April showers, so it’s only natural to find them confusing.  To some they’re like a treacherous forest, where one dollar or step too far can lead you over a cliff.  You’ve probably heard the notion: “If I pick up more hours it will push me into a higher tax bracket, and I’ll end up with less money than if I hadn’t taken overtime in the first place.”  To put it simply, that’s almost never true.  It’s important to remember that as taxable income (minus deductions and exemptions) pushes into higher brackets it is subject to a “graduated rate” that applies specifically to…to… You fell asleep, didn’t you? All right, forget all that.  We’re not learning about taxes.  No “alternative minimum” this, no “federal withholding” that.  It’s spring.  So let’s talk about strawberries. My family goes strawberry picking every year in my uncle’s humongous strawberry patch.  He loves strawberries.  Loves ‘em so much he thinks everyone should have some.  But he also wants everyone to see the “fruits of their labor”.  So instead of splitting ‘em all evenly, or letting everyone keep what they pick, he came up with a system of colored buckets and freezers. Yeah, he’s kind of crazy.  But here’s how it works: First, everyone gets a white bucket.  The white bucket is special.  Every strawberry you put into the white bucket you get… | Read More »

Don’t Panic! RMDs are part of your IRA’s natural aging process

They grow up so fast.  At first it’s all about baby steps: a little bit of Apple to chew on, some Disney to watch, maybe even some Starbucks (for yourself) after they keep you up all night.  As they gain confidence you let them dress themselves, no matter how silly their Small-Cap might look.  You watch with pride as their Growth and Development starts paying Dividends.  But now your IRA has entered its troublesome “RMD stage” and left you with an ever growing terror that your once charming retirement fund will break your happiness, your peace of mind, and most importantly your tax brackets.  What do you do? First of all, don’t panic.  This is a natural part of the IRA aging process.  Once you reach 70 ½, any of your tax-deferred retirement accounts have to start paying out money called “required minimum distributions” (RMDs).  These mandatory withdrawals have a reputation for causing headaches because you can’t control when they happen or how much (tax) damage they might cause.  Your account starts acting like a teenager, only it’s more likely to own part of Facebook than log into it.  And just like a teenager, it has energy that needs to be channeled.  The key is patience and planning. The good news is that for most, RMDs are manageable.  The first required distribution at age 70 is about three and a half percent.  If a hypothetical retiree starts taking money from their account using the four-percent rule at age 65 (assuming 5% annual returns and 3% inflation), the amount they withdraw every year will always be greater than their RMDs.  What this boils down to is the average person is likely to run out of money on their own (in this case at age 99), without having to worry about a “required” distribution. But not everyone falls into this category.  Many retirees have a pension or spend frugally.  Others keep working… | Read More »

When Hobbits and the 4% rule will shape the fortunes of all

It began with the forging of the Great Rules.  Three percent annual returns were given to treasury-bills, immortal, fairest, and surest of all investments.  Five percent was given to bonds, disciplined and reliable sources of revenue.  And seven, seven percent was given to company stocks, which above all else desire  capital return.  For within these rules were bound the benchmarks to govern any retirement portfolio.  But they were all of them relieved, for another rule was made.  Deep in the land of California, under the blistering sun of San Diego, the great financial planner William Bengen forged a master rule in secret, and into this rule he poured all of his foresight, his experience, and his will to encompass any retirement scenario.  One rule to ring them all. What I am discussing, for those who don’t fantasize about Lord of the Rings featuring a plucky band of accountants, is the “four percent rule.”  I hope to cover what it is, the reasoning behind it, and its validity in current market conditions.  And no orcs, I promise. Planning for income needs in retirement is difficult under the best of circumstances.  On the one hand is a retiree with a large balance in their retirement account, saved up over a lifetime of hard work.  On the other is an unforeseeable number of years of living expenses, with unpredictable market returns and unknowable inflation. Faced with this conundrum, William Bengen researched the historical record to determine not which plan could work, but which one always works.  His study, published in 1994, found that a four percent withdrawal rate provided a minimum of 30 years of retirement income.  This proved true across many financial crises, from the Great Depression to the stagflation of the seventies.  He experimented with a variety of allocations and his insights were far-ranging, but for retirees the take-away was this: the most you can withdraw from your portfolio with (almost)… | Read More »

We want YOU to understand when to take Social Security

He’s always been a strange uncle and now he’s saying he wants YOU to help with a few chores around the house. But nothing is ever easy with this guy.  He offers to pay you twenty dollars in two years or thirty dollars in five years. Pulling out five different charts, he says his payment plan is all very simple, and points to numbers like a mad scientist.    Words like “indexing”, “inflation”, and “credits” fly like spittle from his mouth. Cautiously you back away, hoping against hope that he will put himself to sleep with his ranting.  You mumble that you hear someone calling, and turn: tumbling, fleeing, running, sprinting.  You’re safe.  For now. Sadly, most Americans approaching retirement don’t have this option.  They must confront the intricacies of Uncle Sam’s Social Security head on.  And while it would take a novel to fully explore the pros and cons of different filing strategies, I hope to analyze one of the more common ones: out-investing Social Security. The strategy goes like this: take Social Security at the earliest possible age (62) and reinvest the benefits, with the intent of using market returns to exceed the penalty for starting benefits early.  There are some advantages to this tactic.  It creates an asset reserve that can be used for expenses or gifting during the retiree’s lifetime.  If the retiree dies young, he or she will have the benefit of having received more Social Security Security and more investment returns.  And even if they live a long life, excellent returns on their investments may overshadow the loss to Social Security benefits. However, there are several counterarguments. The first is that Social Security itself offers very competitive returns.  Each year benefits are delayed after 62, they will increase anywhere from five to eight percent.  This is simple interest rather than compound, but over an eight year period the difference isn’t severe.  To get similar average… | Read More »