You’re Running out of Time to Reverse this Retirement Withdrawal and Save on Taxes

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Required Minimum Distributions (RMDs) are the annual withdrawals you must take from your individual retirement account and 401(k) plans after you reach age 72 (or age 70 ½ if you turned 70 ½ prior to January 1, 2020).  The CARES Act, the coronavirus relief act that took effect this spring, allowed retirement account holders to bypass required minimum distributions for 2020. Those that inherited IRAs are also allowed to skip the RMD this year.  (https://www.irs.gov/pub/irs-drop/n-20-51.pdf)

For those of you who have taken a Required Minimum Distribution (RMD) from your retirement savings at some point in the year, the clock is ticking for you to put that money back. If you already took the money out, you have until August 31st to put it back.  However, you shouldn’t wait much longer than August 20th, as there are several steps and contacts involved in the process. In order to avoid any errors in the transaction, it is advised to return any RMD funds as soon as possible. It’s important to note that this RMD waiver only qualifies for 2020, meaning next year you’ll be required to take your distribution as per usual. 

RMDs from traditional IRAs and 401(k) plans are subject to income taxes, so waiving the distribution or returning the funds could help you save on levies. But, make sure to give back the income taxes your custodian may have withheld, not just the net amount you may have received.

In other cases, some retirees opt to split their annual RMDs into 12 monthly disbursements, which means they have to return their monthly RMDs. In this scenario, you may have taken multiple distributions over the course of the year. Therefore, you’ll have to contact your custodian and have them hold the payments for the remainder of the year. You are allowed to replace the payments you have already received, too, but just ensure you cover the taxes withheld and act quickly.

Lastly, since the tax rules changed so rapidly this spring amid the coronavirus pandemic, savers should ensure that their custodians are marking the transaction as a “return of funds” and not a “contribution”, where you’d essentially be getting additionally taxed. 

Make sure to talk with your custodian to see if you are squared away and eligible to return your mandatory distribution for the year. If you have any questions or concerns about your RMDs, please reach out to us at info@shermanwealth.com and we’d be happy to assist you in any way. 

Tax Scams

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Tax season is upon us and, unfortunately, with that comes a variety of tax fraud.  These scams often involve phone calls, phishing, identity theft and fraudulent accountants.  Phone scams are one of the most prevalent forms of fraud and have cost victims more than $72 million since October 2013.  The good news is that data suggest some hoaxes are on the decline due to stepped-up security efforts from the IRS, but that doesn’t mean they still aren’t happening.  Here are a few things to look out for to prevent yourself from falling prey to these scams.

These schemes involving phone calls typically threaten arrest, deportation or license revocation if the victim doesn’t pay a fake tax bill.  Victims sometimes give sensitive personal information that can be used for identity theft. In order to prevent this, don’t ever give out personal information to anyone you don’t know over the phone.  The IRS never makes initial contact with taxpayers via an unsolicited phone call and never asks for personal information over the phone.

Phishing is another way that fraudsters use e-mails, text messages, websites and social media to bait taxpayers into providing their personal information or clicking a compromised link that can then be used to install malware onto a computer or other device.  These crooks often pose as a legitimate organization, such as a bank, credit card company or government organization like the IRS and might promise a big refund or personally threaten you. Don’t ever open attachments or click on links in suspicious e-mails. The IRS generally only contacts people by mail.

Another form of tax fraud is identity theft.  This occurs when thieves typically steal a Social Security number or individual taxpayer identification number to file a fraudulent return claiming a tax refund.  If a thief claims a refund in your name, you still will get a proper tax refund, but it will take time and a lot of paperwork.

It is also important to do your research in order to avoid fraudulent accountants.  There are scammers who pose as tax professionals and rip off customers via refund fraud, identity theft and other schemes.  These criminals typically promise overly large tax refunds to prey on older Americans, low-income taxpayers and non-English speakers.  Make sure to Visit the Better Business Bureau’s website to run a check. Look for disciplinary actions and the license status for credentialed preparers. For CPAs, check with your state’s Board of Accountancy. The IRS also has some tips on how to choose a tax professional.

In order to avoid these types of scams, the best thing is to trust your gut.  If something seems to good to be true, it probably is. Never give out personal information via a phone call or e-mail and if you have questions about anything, ask for a detailed letter.

A New IRS Withholding Tax Calculator Eliminates the Guesswork

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Last week, in response to confusion surrounding the 2018 tax law that was passed in December, the IRS released an updated online Withholding Calculator. The tool is designed to help taxpayers make sure they are not wildly underpaying or overpaying what they will owe.

The new law is highly complex and made changes that included increasing the standard deduction, removing personal exemptions, increasing the child tax credit, limiting or discontinuing certain deductions, and changing the tax rates and brackets.

The online calculator should go a long way to help employed taxpayers plan ahead, particularly those in middle-income and upper middle-income brackets.

This is important because you don’t want to be withholding too much –in effect giving the government a free loan of money you could be investing in your home, the market, educational savings funds, or just your day-to-day needs. On the other hand, you don’t want to be withholding to little and risk facing an unexpected tax bill or penalty at tax time in 2019

According to the IRS some of the groups who should check their withholding are:

  • Two-income families
  • People with two or more jobs or seasonal work
  • People with children who claim the Child Tax Credit (or other credits)
  • People who itemized deductions in 2017
  • People with higher incomes and more complex tax returns

According to Acting IRS Commissioner David Kautter, about 90 percent of taxpayers would have “some adjustment one way or the other” to the amount they are withholding. That’s most of us.

The changes do not affect 2017 tax returns due this April. Your completed 2017 tax return can, however, help you input data to the Withholding Calculator to determine what you should be withholding for 2018 to avoid issues when you file next year. And if you do need to change the amount you are withholding (remember- 90% of us might), there is also a new version of the W-4 form to download and submit to your employer.

More information is available from the IRS here: Withholding Calculator Frequently Asked Questions.

And if you have questions about how these important changes may affect you, please call us for a free consult or reach out to your CPA.

How Will The Proposed Tax-Plan Affect You?

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On Wednesday, the Trump Administration released their nine-page tax plan titled “United Framework for Fixing Our Broken Tax Code.”  That’s a mouthful.  The full text of the plan can be found here.  So how will the proposed tax-plan affect you?

The reviews are in, and they suggest that while the plan is considered “finalized,” there is still a high level of uncertainty and vagueness in the plan that makes it difficult to assess how it would impact the average American.  

Some have suggested that President Trump and the Big 6 (Gary Cohn, Steve Mnuchin, Mitch McConnell, Sen. Orrin Hatch, Paul Ryan and Rep. Kevin Brady) might not have learned as much as they could have from the failure to repeal and replace the Affordable Care Act, which arguably was defeated due to a lack of clear details and shortage of bipartisan support.  In a repeat tactic, the push for passing the bill under “budget reconciliation” would require only a simple majority in the Senate to pass the law.  But it should be noted that this can only happen if projections show that the total revenue differential over the next 10 years is $1.5 trillion or less.  Right now, projections place it at $2.5 trillion over the next 10 years.  That means the GOP will either need bipartisan Senate support with 60 votes or find $1 million in reduced projections.  

Here are some of the highlights of the proposed plan and how they could impact your personal income taxes if they should be passed:

  1. Fewer Tax Brackets – Instead of the seven tax brackets we face today ranging from 10% to 39.6%, the new plan proposes only three: 12%, 25%, and 35%.  Because the plan does not specify where these cut-offs will be, though, we can only speculate on how these will impact individuals positively or negatively.  If speculation is correct, those currently facing 28% and 33% tax rates would see a tax cut to the new 25% rate, which would be beneficial.  The idea of adding a fourth bracket for the wealthiest Americans has also been floated.

  2. Doubles the Standard Deduction, but Eliminates Personal Exemptions – The marketing tactic for the bill is that it is a huge break to middle-class Americans by doubling the standard deduction from $6,350 to $12,000 for single filers and from $12,000 to $24,000 for joint filers.

    There is a catch, though.  These increases are being offset by the elimination of personal exemptions. The result is what seems like a 50% increase to most taxpayers, in reality, is closer to 15%.

  3. Reduction of Elimination of Itemized Deductions – If in the past you have chosen to itemize your deductions, you could be getting the short end of the stick here.  The plan calls for reductions or elimination of many itemized deductions, without providing specifics on which ones.  It has only been stated that they will keep the deductions for home mortgage interest and charitable contributions.  It also mentions benefits that encourage work, higher education and retirement savings, but provides no details on these.

    The largest red flag for many is concerning the elimination of state and local tax deductions.  Currently, you can deduct what you pay in state and local taxes from your federal income bill.  If this is eliminated, it could disproportionately affect those who live in high-tax states such as Connecticut, New York, New Jersey, California, and Maryland.  Only two days after the plan was released, objections from Blue-state Republicans have caused them to reconsider eliminating these deductions.

    Additionally, homeowners or anyone paying real estate taxes will see that their property taxes are no longer deductible under the new plan.  Again, this will have a disproportionately large impact for those living in states with high real estate taxes.
    Below is a breakdown of what the new and old tax brackets could look like for single filers:
    Source: Business Insider

  4. Changes for Families– There may be some significant changes to the tax code surrounding families as well, including single parents and households with two or more children.

    Currently, single parents fall into a favorable tax bracket somewhere in between single and married-filing-joint rates as well as a 50% boost to their standard deduction.  The new plan would likely eliminate this, meaning single parents could face higher rates.

    That being said, these cuts could potentially be offset by an unspecified “significant increase” to the Child Tax Credit.  Depending on the size of this Child Tax Credit, households with a two or more children could also see increased rates because of the elimination of the exemption based on the number of children.

  5. Eliminates the Death Tax and Alternative Minimum Tax – The estate (“death”) tax only currently applies to 0.14% of Americans, whose assets exceeded $10.9 million and did not hire a competent estate planner.  So this likely does not affect you, but it would be eliminated under this plan.

    The alternative minimum tax forces those who have an outsized number of deductions to pay an alternative tax rate instead.  The truth is, very few people understand it anyway.  This is likely a good thing, especially if the goal is simplicity.

  6. Small Businesses, including ours! – In terms of small-business owners, there is a whole separate set of changes to be considered.  For ‘pass-through’ businesses like ours, the plan wants to lower the maximum rate from 39.6% to 25%, which is particularly appealing to making smaller firms more competitive.

    Questions still surround this due, though, to Steve Mnuchin’s vague statements regarding limitations on what types of businesses will get this lowered rate as well as how they will distinguish between personal income and business income.  Additionally, many have pointed out that nine in 10 businesses that pass through their income already pay at the 25% rate or less, meaning this change could be ultimately inconsequential.

    For larger corporations, the plan proposes lowering the tax rate from 35% to 20% and a one-time repatriation of overseas assets at an unspecified lower rate.   

 

If you have any questions related to your specific situation, don’t hesitate to contact us here.  We will keep you updated as more developments are made and the plan evolves.  

 

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The views expressed in this blog post are as of the date of the posting, and are subject to change based on market and other conditions.  They are for information purposes only. This blog contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.

Please note that nothing in this blog post should be construed as an offer to sell or the solicitation of an offer to purchase an interest in any security or separate account. Nothing is intended to be, and you should not consider anything to be, investment, accounting, tax or legal advice. If you would like investment, accounting, tax or legal advice, you should consult with your own financial advisors, accountants, or attorneys regarding your individual circumstances and needs. No advice may be rendered by Sherman Wealth unless a client service agreement is in place.

If you have any questions regarding this Blog Post, please Contact Us.

Don’t Expect to Win With Actively Managed Funds

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This article was originally published on NerdWallet.com

Trying to pick individual stocks is a losing game, and this doesn’t just apply to individual investors. It’s also true for professionally run, actively managed mutual funds.

Actively managed funds are tasked with picking a collection of stocks and bonds that will outperform market indices, or benchmarks, such as the S&P 500 or the Dow. They’re armed with Ph.D. analysts, hundreds of interns, and tools and research to which very few of us have access — but they can’t consistently beat their benchmarks by enough to justify their costs.

Long-term underperformance

Eighty-six percent of actively managed funds failed to beat their benchmarks in 2014, according to the S&P Dow Jones Indices scorecard. “So what?” you may say, “That’s only one year.” But 89% of funds failed to beat their benchmarks during the past five years; 82% failed to do so during the last decade.

The following data help illustrate how unlikely it is for active managers to beat the market over longer periods. During a one-year period, a high percentage of active managers in some categories may outperform their benchmarks. But over five- and 10-year periods, fewer active managers outperform.

Percentage of Actively Managed Funds That Outperform Benchmarks

1 YEAR 5 YEARS 10 YEARS
Source: 2015 Morningstar data
Large-cap value 36.5 19.6 33.7
Large-cap core 28.7 16.7 16.6
Large-cap growth 49.3 11.9 12.2
Mid-cap value 53.5 22.7 42.3
Mid-cap core 42.1 27.7 11.0
Mid-cap growth 41.6 26.0 32.4
Small-cap value 66.7 38.0 38.3
Small-cap core 44.7 32.8 23.1
Small-cap growth 22.2 20.5 23.1

Some managers do outperform the market, but picking a winning manager is as tricky as picking winning stocks. If you still think you can find “a good manager” who is the exception, consider this widely accepted Wall Street rule of thumb: Past performance doesn’t guarantee future performance. A manager who outperformed last year may not do it again this year.

Reasons for underperformance

There are a few main reasons actively managed funds underperform, aside from picking the wrong investments:

FEES

Many actively managed funds charge 1% to 2% per year in management fees, while a passively managed exchange-traded fund could charge as little as 0.1% to 0.2% per year. And many actively managed mutual funds are loaded funds, which means you’ll pay a sales charge, typically between 4% to 8% of your investment, when you buy or sell the fund — though the fee may decrease the longer you stay invested. Compounded over time, these higher fees can eat up a lot of gain, reducing overall returns.

TAXES

Because actively managed funds try to time the market and pick winners, they buy and sell positions frequently. These transaction costs reduce the fund’s returns, and all the buying and selling can also create taxable gain. Fund managers have no incentive to avoid this because they simply pass those taxable gains on to you, the shareholder.

MARKET EFFICIENCY

Some argue that markets are becoming more efficient, making it difficult to identify overvalued or undervalued stocks. The efficient market hypothesis states that stocks are constantly adjusting to news and information, and thus their share prices reflect their “fair value.” In simpler language, other than in the very short term, there are no undervalued stocks to buy or inflated stocks to sell. This makes it virtually impossible to outperform the market through individual stock selection and market timing.

An unsustainable approach

Whether active management can outperform is a controversial topic. Many experts dismiss the science and say that they can indeed beat the market. Some of them may even do so for a year or two, or even five, but what about over the long run? It’s simply not sustainable, and to think otherwise is dangerous.

If the data shows that the vast majority of the brightest and most well-equipped professional investors can’t beat their benchmarks, why should you believe anyone who says they can?

This story also appears on Nasdaq.

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The views expressed in this blog post are as of the date of the posting, and are subject to change based on market and other conditions. This blog contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
Please note that nothing in this blog post should be construed as an offer to sell or the solicitation of an offer to purchase an interest in any security or separate account. Nothing is intended to be, and you should not consider anything to be, investment, accounting, tax or legal advice. If you would like investment, accounting, tax or legal advice, you should consult with your own financial advisors, accountants, or attorneys regarding your individual circumstances and needs. No advice may be rendered by Sherman Wealth unless a client service agreement is in place.
If you have any questions regarding this Blog Post, please Contact Us.

Why Reducing Your Tax Refund is a Good Thing

With tax day fast approaching, many people are counting on receiving a big check back from the Government. While you’re probably looking forward to this windfall, there are reasons why you may wish to minimize your end-of-year refund.

Why Big Refunds are Bad

Taxes are refunded to you when the Government takes too much of your pay each pay period. By overpaying each paycheck, only to get the money returned to you once a year, you are essentially lending the Government money at zero percent interest.

This is money that could have been budgeted for and spent, or invested, throughout the year. Even if you had put the money in a savings account over the year, you still would be better off.

How to Minimize Your Refund

In order to adjust the amount that is withheld for the IRS each pay period you need to fill out/change your W-4 form.

The W-4 allows you to specify allowances or exemptions that you are eligible for.

These can include:

  • Donations to charitable organizations
  • Interest on a home mortgage
  • Interest on student loan debt
  • Contributions to traditional IRAs

The W-4 form estimates the amount that you would receive from a tax refund. This amount is then distributed over the number of weeks remaining in the tax year, lowering the amount withheld from your paycheck each pay period.

You should also look into filling out a new W-4 every time you have experienced a major change in your life. Examples of this include:

  • Switching jobs
  • Marriage
  • Having a child
  • Losing a dependent (They either file their own tax return, or you can no longer claim them)

While trying to lower the amount that is withheld in taxes each pay period generally makes sense, it may be prudent to not list all of the exemptions you are eligible for on your W-4.

Why You May Not Want to Claim all Your Allowances

While having too much in taxes withheld can be compared to lending the Government money at a rate of zero percent interest, the reverse is also true.

If you underpay in taxes each paycheck, you end up owing money to the Government. In theory this is great. You could put the money in a savings account, and then at the end of the year pay back the Government while pocketing the interest that you collected.

In practice however this is not a prudent strategy for most people.

Individuals have a tendency to spend money that they have, and forget about longer-term consequences of their actions. Additionally while receiving a refund at the end of the year is exciting, the opposite is also true.

This is why it may make sense for you to leave a few deductions you are eligible for unlisted on your W-4. This ensures that you receive a tax refund, albeit a smaller one, rather than owing money.

What to Do When You Do Receive a Refund

While this advice can be helpful for next year, chances are this year’s tax season will provide you with a large refund.

If you do receive a large refund there are a series of things you can consider to maximize its value. Here are a few ideas to get you started:

  • Invest in yourself – Sometimes the best investment you can make is in yourself. Consider buying a book or taking a class to help improve your performance in work or at life.
  • Get your will done – this can often cost less than a $1,000 in total but can save your beneficiary’s significantly more both in terms of money as well as headache
  • Put money into a college savings plan
  • Pay down your mortgage
  • Invest in a non-tax-exempt account – if you have already maxed out your IRA
  • Save for a rainy day
  • Open/add to an IRA
  • Pay off student loan debt
  • Pay off credit card debt – if you have any credit card debt, this should be an immediate priority
  • Save the money and increase your 401(k) contributions – put your money in a safe place such as a savings account, and bump up your 401(k) contributions to reflect the fact that you have this money sitting on the side.

Regardless of what you do with your tax refund, it is important that you come up with a plan. A trusted financial planner can help you in the process of creating one.

With over a decade’s worth of experience in the financial services industry Brad Sherman is committed to helping individual investors plan and prepare for retirement.

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The views expressed in this blog post are as of the date of the posting, and are subject to change based on market and other conditions. This blog contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.

Please note that nothing in this blog post should be construed as an offer to sell or the solicitation of an offer to purchase an interest in any security or separate account. Nothing is intended to be, and you should not consider anything to be, investment, accounting, tax or legal advice. If you would like investment, accounting, tax or legal advice, you should consult with your own financial advisors, accountants, or attorneys regarding your individual circumstances and needs. No advice may be rendered by Sherman Wealth unless a client service agreement is in place.

If you have any questions regarding this Blog Post, please Contact Us.