Category Archives: Income

VA Disability Payments to Increase in 2023

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Veterans Administration (VA) disability compensation rates are increasing in 2023 based on Social Security’s cost of living adjustment (COLA).

The official compensation tables will be provided by VA in December 2022.

Veterans who meet the requirements for a 100 percent VA disability rating become eligible for a host of additional benefits. Here are fourteen potential VA Disability benefits:

  1. Monetary compensation
  2. Free health care and medication
  3. Travel allowance for scheduled medical appointments
  4. Dental care
  5. Funding fee waiver with VA Home loans
  6. Employment assistance
  7. Veterans Readiness and Employment
  8. Additional compensation for eligible dependents
  9. Concurrent receipt of Military Retirement pay
  10. Educational assistance for dependents
  11. CHAMPVA – dependents can receive health care
  12. Burial and plot allowance
  13. Uniformed services ID card
  14. Adaptive housing and automobile grants.

In 2022, a veteran with a 100 percent VA disability rating receives compensation of at least $3,332.06 per month.

Monthly compensation amounts increase if a veteran has qualifying dependents, such as a spouse, children, or parents.

References:

  1. https://www.benefits.gov/agencies/U.S.%20Department%20of%20Veterans%20Affairs
  2. https://vaclaimsinsider.com/100-disabled-veterans-benefits/

Dividend Growth

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“One common trap that dividend investors can fall into is chasing stocks with high yields when they should be buying dividend growth stocks that can promise years of steady income raises.” ~ Dan Burrows, Senior Investing Writer, Kiplinger.com

Over the last few years when non-dividend paying growth stocks were delivering significant double-digit gains in the span of months, it was easy to ignore the benefits of equity income, writes Stephen Dover, CFA, Chief Market Strategist, Franklin Templeton Institute. Today, given rising interest rates, slowing growth and heightened volatility, the role of dividends is changing amid a more challenging environment for multiple expansion.

Over the long-term, dividends have proven to be a significant driver of total return. Over the last 31 years, spanning January 1990 through December 2021, the receipt and reinvestment of dividends accounted for about 50% of the cumulative total return of the S&P 500 Index, according to Franklin Templeton. In addition, dividend growers, proxied by the S&P 500 Quality High Dividend Index, have outperformed their value and growth counterparts over the more than two decades since 1995.

Dividend payouts can act as a useful quality barometer. A solid track record of growing dividends consistently and sustainably over an extended period of time is typically seen as a signal of healthy company fundamentals, astute and efficient capital allocation and a firm commitment to shareholder value.

Dividend payouts are often cut during periods of grave economic stress, particularly in the most vulnerable companies.

  • Dividends offer evidence of financial strength. Historically companies that initiated or increased their dividend have significantly outperformed those that cut or don’t pay a dividend.
  • Often, stocks with the highest dividend yields come from companies whose market prices have fallen, indicating stress.

In the U.S., 242 companies cut or suspended dividends, according to Capital Group. This number of dividend cuts and suspension nearly match the total for the previous 11 years combined.

After historic cuts, some U.S. companies are restoring dividends

Source: Wolfe Research, LLC. Copyright © Wolfe Research, LLC 2021. All rights reserved. Only companies with market cap of at least $250 million included. Reinstated dividends statistic is through 5/31/21.

But the picture is improving. With the rollout of COVID-19 vaccines and the reopening of economies, many U.S. companies have begun to resume payments.

Many investors, when they search for dividend paying stocks, tend to start with companies that pay the highest dividend yields. These companies can be sound investments, but the high yield can also be a warning sign. “Companies that have very high dividends to start may not be able to sustain them,” Joyce Gordon, Capital Group equity portfolio manager, notes. “The high yield may indicate a company is a melting ice cube, and their business is in decline and they’re not reinvesting.”

Gordon says that dividend growing stocks represent a compelling value for investors. “I look for companies that are yielding around 2.5% to 3.0%, and that are growing their dividends and earnings around 10% or 12% a year. Today I am finding a number of companies that meet that criteria across a wide range of sectors and global markets.”

The best dividend stocks – companies that raise their payouts like clockwork decade after decade – can produce superior total returns (price plus dividends) over the long run, even if they sport apparently ho-hum yields to begin with.

Dividend growers are strong companies that are likely to be even stronger in five or 10 years. “I look for a company that can demonstrate the capacity and commitment to raise its dividends over time,” Gordon says. “I look for dividend growth that matches the underlying earnings growth of the company.”

Dividend growers historically have tended to generate greater returns than other dividend strategies, while also keeping up relatively well with the broader market. People assume that growth companies far outpaced dividend paying stocks over the past decade, and that’s true when you look at the highest yielding stocks. But dividend growers did nearly as well as the overall market.

By providing a growing stream of income, dividend growth can be a sign of company executive management’s more rigorous capital allocation process. “Because they are committed to setting aside some proportion of their earnings for investors, they tend to have better discipline and may be less likely to make some ill-advised acquisition,” Gordon says.

Because it is reflective of growing earnings, dividend growth can also offer a measure of resilience against interest rate hikes, Gordon adds.

Reinvested dividends. The power of reinvested dividends

One company that has consistently grown its dividends is McDonald’s. To get a sense of how regularly reinvesting dividend payments can compound over time, consider a hypothetical $100,000 investment in the company for the 20 years from December 31, 2000, through December 31, 2020, with all dividends reinvested.

Sources: Capital Group, FactSet. Growth rate calculations for value of shares from reinvested dividends and dividends paid use the first year’s dividends payment ($676) as a starting value.

Reinvested dividends tend to provide a downside cushion for total returns during periods of modest capital gains. The 2000s—the “lost decade” for stocks—is a crucial case-in-point. While the S&P 500 delivered annualized total returns of -0.95% in the 10 years from January 2000 through December 2009, the figure would have been worse had dividends been removed from the calculation. Annualized price return for the index in the 2000s averaged -2.72% versus dividends, which provided 1.77% annualized return over the 10-year period.

Using the power of the compounding of re-invested dividends is a good way to build real wealth, simply. Albert Einstein has called compound interest the “Eighth Wonder of the World,” since the power of compounding can be a wonder to behold. The magic of compounding, as Ben Franklin famously said, “Money makes money. And the money that money makes, makes money.”

“Compound interest is the Eighth Wonder of the World. He who understands it, earns it. He who doesn’t pays it” ~ Albert Einstein

Compound interest or “interest on interest” is effectively what compound interest is for investors. “Interest on Interest” or “dividends on dividends” is why the compounding effect on dividend reinvestment creates wealth. The longer you reinvest the dividends, the more dividends you receive because you own more shares. And the cycle continues as long as the investor stay invested in the market and reinvests his/her dividends.

S&P 500 Dividend Aristocrats.

The objective is to find companies that are growing their dividends faster than the market average over time. The Dividend Aristocrats are companies in the S&P 500 Index that have raised their payouts for at least 25 consecutive years. This list of the S&P 500’s best dividend stocks is a mix of household names and more obscure firms, but they all play key roles in the American economy. And although they’re scattered across pretty much every sector of the market, they do all share one thing in common: a commitment to reliable and long-term dividend growth.

References:

  1. https://www.capitalgroup.com/advisor/insights/articles/dividend-growth-special-sauce-long-term-investing.html
  2. https://www.franklintempleton.com/articles/strategist-views/the-case-for-dividends
  3. https://www.kiplinger.com/investing/stocks/dividend-stocks/604131/best-dividend-stocks-you-can-count-on-in-2022
  4. https://www.wealthplicity.com/investing-strategy/stocks-and-equities/the-power-of-compounding-dividend/

All investments involve risks, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested.

International Dividend Investing

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U.S. dividend stocks continue to sport relatively low yields compared with other assets, especially as bond yields climb amid the Federal Reserve’s rate-hike.

But, there are alternatives assets to U.S. dividend stocks…international stocks:

  • MSCI Europe index was yielding 3.4%,
  • Japan’s Nikkei 225 index was yielding 2%,
  • MSCI Emerging Markets index was at 3.1%.
  • S&P500 was yielding 1.6%.

“Outside the U.S., there’s more of a culture of returning capital to shareholders through dividends rather than buybacks,” says Julian McManus, a portfolio manager at Janus Henderson Investors.

International stocks offer an higher yield than U.S. equities, though there are risks. Early in the pandemic, for example, dividend cuts went much deeper overseas than they did in the U.S.

Additionally, most countries impose a withholding tax on dividends paid to nonresidents. However, those withholding taxes, in many cases, can be credited against the U.S. shareholder’s U.S. tax liability, according to Robert Willens, a New York–based accounting and tax expert.

Another risk international dividends pose is that they can be more apt to get cut in economic downturns.

U.S. investors face a trade-off when it comes to international dividends: higher yields with higher risk.

References:

  1. Lawrence C. Strauss, Why Income Seekers Should Consider International Stocks, Barron’s, August 5, 2022.
    https://www.barrons.com/articles/international-stocks-income-dividends-yield-51659585601

The Power of Dividends

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Dividends account for about 40% of total stock market return over time

Value of dividends

There are 2 ways to make money in the stock market: capital appreciation and dividends.

Capital appreciation—an increase in a stock’s price—gets most of the attention, but dividends can be surprisingly powerful.

Fidelity Investments’ research finds that dividend payments have accounted for approximately 40% of the overall stock market’s return since 1930.

What’s more, dividends can help prop up returns when stock prices struggle. For example, stock prices in the S&P 500 fell during the 1930s and 2000s, but dividends almost completely offset the decline. In the 1940s and 1970s, when inflation surged, dividends accounted for 65% and 71% of the S&P 500’s return, respectively.

“From a multi-asset income perspective, I am always seeking investments that pay a high enough level of current income to help cushion the blow during down markets. Conversely, in rising markets, this income component contributes to the overall total return of the investment. In this regard, companies that pay a sustainable and growing dividend have the potential to grow their income to keep up with inflation,” says Adam Kramer, portfolio manager for the Fidelity Multi-Asset Income Fund

References:

  1. https://www.fidelity.com/learning-center/trading-investing/inflation-and-dividend-stocks

Taxes: Income and Property

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“In this world, nothing is certain except death and taxes.” Ben Franklin

After-tax income inequality has grown over the long term. Between 1979 and 2018, the share of aggregate after-tax income of the top 1% of households grew significantly from 7.4% to 13.6%. In contrast, the shares for the bottom 90 percent of households declined. Tax Policy CenterWealth inequality has also widened. The average white household had $402,000 in unrealized capital gains in 2019, compared with $94,000 for Black households and $130,000 for Hispanic or Latino households. These disparities have generally widened over time. Tax Policy Center

Virtually all families hold some amount of financial assets, broadly defined as brokerage, checking, savings and retirement accounts to name a few. While 98% of families held checking or savings accounts in 2019, only 50% of families held retirement accounts and 15% owned stocks. Tax Policy Center

Salaries and wages are the largest sources of income for most households. In 2018, they comprised 68% of total adjusted gross income across all individual income tax returns, but only 17% for those with incomes over $10 million. Tax Policy Center

Income from capital gains made up about 8% of aggregate adjusted gross income (AGI) in 2018, but this varied by income level. For those with AGI over $10 million, capital gains accounted for nearly half of their income. Tax Policy Center

In 2019, the median net worth for those with college degrees was four times higher than for those with high school diplomas and nearly 15 times higher than for those without high school diplomas. Tax Policy Center

Overall, the share of US families with education loan debt went from 9% in 1989 to 21% in 2019. About 30% of Black families had education loan debt in 2019, compared with 20% of White families and 14% of Latino families. Tax Policy Center

Federal taxes are moderately progressive overall. In 2018, the top 1% had 16.6% of total income before taxes and 13.6% after taxes. Contrastingly, the lowest quintile had 3.8% before taxes and 7.1% after taxes. Tax Policy Center

In fiscal year 2019, state and local governments raised $577 billion in property taxes. As a share of general revenue, New Hampshire relied the most on property tax revenue (36%) whereas Alabama and New Mexico relied the least (7%). Tax Policy Center

State and local taxes as a share of income ranged from 7% in Tennessee to 15% in North Dakota in 2019. This does not measure comparative tax burdens on states’ residents because it includes taxes on business activities borne by residents of other states. Tax Policy Center

Total tax revenue (including federal, state, and local taxes) as a share of GDP was 24.5% for the US in 2019. Tax Policy Center

Wealthier Americans may be more stressed regarding inflation, economic uncertainty and market volatility, but lower-income Americans have much more to fear from rising prices and are experiencing greater daily impact to their wallets. They tend to have less financial cushion to handle higher prices for food, gas, and other necessities, according to the Tax Policy Center.

The above financial inequality and tax snippets are interesting facts/information garnered from the nonprofit Tax Policy Center.

References:

  1. https://www.taxpolicycenter.org/fiscal-fact/top-1-income
  2. https://www.axios.com/wealth-inflation-fears-money-financial-assets-52779e2d-8940-4b87-85cd-29c65744fb29.html

How the Economy Works by Ray Dalio

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“Credit is important because it means borrowers can increase their spending. This is fundamental because one person’s spending is another person’s income.” Ray Dalio

Ray Dalio is one of most successful hedge fund managers and founder of Bridgewater Associates. He credits much of his success to guiding principles that he has used to make decisions both in his professional and in his personal life.

How the Economic Machine Works – “The economy is like a machine. At the most fundamental level it is a relatively simple machine, yet it is not well understood,” explains Ray Dalio.

Economic principles discussed:

  • Economy – The economy is simply the sum of all transactions repeated again and again over a long period of time. Money and credit account for the total spending in an economy.
  • Transactions – the exchange of money or credit between a buyer and seller for goods, services or financial assets.
  • Markets – “All buyers and sellers making transactions represent the market. For example, we have wheat markets, stock markets, steel markets, oil markets and so on.The combination of all of these sub-markets is the entire market, or the entire economy.” Ray Dalio
  • Governments – the biggest buyer and seller of goods, services and financial assets. The government consists of two parts: the central government that collect taxes and spend money; and, the central bank which controls the amount of money flowing through the economy. It does this by influencing interest rates and printing more money.
  • Central Bank – The Central Bank can only buy financial assets, not goods and services. To support the economy, the Central Bank buys Government bonds which gives the Central Government the ability to buy goods and service.
  • Price – the result of total spending / quantity sold.
  • Credit – Credit “is the most important part of the economy because it is the biggest and most volatile part”. Credit can be created out of thin air — in fact, in 2016, the US$50 trillion of the US$53 trillion in the economy was credit, as opposed to ‘real’ money. Credit is important because it means borrowers can increase their spending. This is fundamental because one person’s spending is another person’s income. Credit is bad when it finances over-consumption and borrowers are unable to pay the debt back.
  • Lenders – lend money to make more of it. When lenders believe borrowers will repay, credit is created.
  • Borrowers – borrowing is pulling spending forward which relates to borrowing money to buy something you can’t afford, such as a house, a car, a business or stocks. Borrowers promise to repay the amount borrowed (the principal) with interest. Borrowing creates cycles.
  • Debt – Debt allows you to consume more than you produce when it is acquired, and forces you to consume less when you have to pay it back. “When credit is issued it becomes debt. It’s a liability for the borrower, and an asset for the lender. It disappears when the transaction is settled.
  • Interest Rates – When interest rates are high, borrowing is low. When interest rates are low, borrowing is high.
  • Spending – one person’s spending is another person’s income. Total spending is the sum of money spent plus of credit spent.
  • Income – one person’s spending is another person’s income
  • Monetary Cycles – economy expansion and recession cycles.
  • Inflation – inflation is when prices rise. When spending is faster than the production of goods, it means that we have more demand than supply, which results in inflation.
  • Deflation – when spending decreases, prices tend to decline.
  • Expansion – growing markets and increasing transactions
  • Recession – Economic activity decreases, and if unchecked this can lead to a recession.
  • Bubbles – when the price of assets far exceed the value of the assets
  • Debt Burden – When incomes grow in relation to debt, things are kept in balance. But a debt burden emerges when debt growth exceeds income growth. This debt to income ratio is the debt burden.
  • Productivity – innovation and hard working raises productivity, which equates to the amount of goods and services produced.

Three rules of thumb for life

Source: Ray Dalio

According to Dalio, there are “three rules of thumb” with which to navigate the economy, be it in your own businesses, organisations you work at or your personal finances.

  1. Don’t have debt rise faster than income (because debt burdens will eventually crush you).
  2. Don’t have income rise faster than productivity — it will eventually render you uncompetitive.
  3. Do all you can to raise productivity — in the long run that’s what matters most.

References:

  1. https://www.nofilter.media/posts/ray-dalios-economic-machine-12-minute-summary
  2. https://www.amazon.com/gp/product/1501124021/ref=as_li_qf_asin_il_tl_nodl?

Advantages to Taking Social Security Benefits at Age 62

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“Social Security’s trust funds will become unable to pay full benefits starting in 2034, one year earlier than estimated last year.” Social Security Administration Trustee Report

Social Security has two programs, one for retirees and another that provides disability benefits. The Old-Age and Survivors Insurance Trust Fund will become unable to pay full benefits starting in 2033, a year earlier than projected in 2020, while the Disability Insurance Trust Fund will become depleted in 2057, or 8 years earlier, according to Social Security Administration.

The U.S. economic recession caused by COVID-19 led to a drop in U.S. employment and a resulting decrease in payroll tax revenue, which accelerates the depletion of Social Security’s reserves.

When to claim benefits

You can start receiving your Social Security retirement benefits as early as age 62. And, there are advantages and disadvantages to taking your benefit before your full retirement age.  Matter of fact, 31% of women and 27% of men claim their Social Security benefits as soon as they qualify at age 62 in 2018.

  • The primary advantage is that you collect benefits for a longer period of time.
  • The primary disadvantage is your benefit will be reduced. Each person’s situation is different.

The earliest you can apply for Social Security benefits is four months before the month you want your benefits to start, and the earliest your benefits can start is your first full month as a 62-year-old. For example, if you turn 62 in June, your benefits can begin in July, and you can apply as early as March. And, Social Security Benefits are actually paid one month in arrears in August.

There is an exception: If you were born on the first or second day of a month, you can begin collecting your benefits in that month.

You may need your Social Security Benefits as a source of guaranteed income to help pay bills, or if you anticipate not living long enough to reap the rewards of delaying.

If you start taking Social Security at age 62, rather than waiting until your full retirement age (FRA), you can expect up to a 30% reduction in monthly benefits with lesser reductions as you approach FRA.

Delaying can boost monthly payments compare to claiming early. Colleen, single at age 62 would receive $1,450. At 66 1/2 $2,000. At 70, $2,560. Waiting until age 70 would increase Colleen's montly benefits by more than 765 and her lifetime benefits by at least 24%

Social Security replaces a percentage of your pre-retirement income based on their lifetime earnings. The portion of your pre-retirement wages that Social Security replaces is based on your highest 35 years of earnings and varies depending on how much you earn and when you choose to start benefits.

When you work, you pay taxes into Social Security and the Social Security Administration uses the tax money to pay benefits to:

  • People who have already retired.
  • People who are disabled.
  • Survivors of workers who have died.
  • Dependents of beneficiaries.

The money you pay in taxes isn’t held in a personal account for you to use when you get benefits. We use your taxes to pay people who are getting benefits right now. Any unused money goes to the Social Security trust fund that pays monthly benefits to you and your family when you start receiving retirement benefits.

Living in retirement

You’re officially retired and have worked hard to build up your retirement nest egg. As you transition your mindset from saving to spending, you’ll want to now change your focus: Protect what you have, don’t run out of money, develop a housing strategy for where you’ll live over the next 20–30 years, and hopefully, enjoy life as much as you can with your friends and family.

Claiming Social Security at 62 makes sense in several scenarios. Below are four reasons to consider filing as early as possible.

  1. You’re out of work against non-voluntary – Many people are forced out of a job before they’re ready to retire. If you’ve been downsized and can’t find a new job, Social Security could help replace of your regular paycheck. Furthermore, the coronavirus pandemic has forced a lot of seniors out of the workforce, whether due to layoffs or health concerns. If you’re able to compensate for not working by claiming benefits early, do so since it’s a better bet than racking up debt.
  2. You’re out of work temporarily and need money – Maybe you’re not working right now to address a health issue or lay low until the pandemic is over, but you’re confident you can get back out there in six months. In that case, claiming Social Security at 62 could be a smart move because you can actually use that money as a loan of sorts. One lesser-known Social Security rule is that you’re allowed to undo your filing once in your lifetime. If you claim benefits at 62 but are working again in a few months, you can withdraw your application, repay the SSA the benefits it paid you, and then file again at a later age so you don’t slash your benefits in the process. The only catch is that you must undo your claim and repay your benefits within 12 months. But if you can pull that off, you can collect Social Security on a temporary basis without locking yourself into a lower monthly benefit forever.
  3. You’re tired of working and can get by on your Social Security paycheck – Maybe you have the option to work, but at this point in life, you’re tired of doing it. If your expenses are such that you can get by on your Social Security income, or a combination of Social Security and other income sources, then there comes a point when you should let yourself off the hook after a lifetime of hard work. If you’re going to claim Social Security early for this reason, you should make sure to have a healthy retirement savings balance to compensate for a lower monthly benefit.
  4. You Have Minor or Disabled Children at Home – If you have children, eligible grandchildren, or even a spouse providing care for these children at home, these family members may be eligible for a benefit. There’s a rule that states that before benefits can be paid to anyone off of your work record, you have to be receiving benefits. That means filing early could make more sense than waiting. When combined with your benefits, the benefits to children and your eligible spouse can be up to 180% of your full retirement age benefit. If you have children at home that meet the criteria for eligibility, that’s an obvious reason to consider filing early.

It might seem like it makes sense to wait to file until full retirement age, then, when you’d receive $2,000 (versus filing at 62, when you’d only get $1,500 per month).

If you lived until 90, you’d receive an additional $70,000 in benefits for delaying filing until 66 instead of filing at 62. But this calculation doesn’t take into account the benefits paid to your children. While your children would be eligible for benefits based upon your retirement, the kids cannot get benefits until you file. That means your family would able to collect thousands of dollars more in lifetime benefits if you file early and turn on the benefits for your kids.

For every good reason to claim Social Security at 62, there’s an equally good reason to wait. On average, retirement beneficiaries receive 40% of their pre-retirement income from Social Security.

References:

  1. https://www.marketwatch.com/story/social-security-to-become-unable-to-pay-full-benefits-sooner-than-previously-estimated-11630436444
  2. https://www.ssa.gov/benefits/retirement/learn.html
  3. https://www.aarp.org/retirement/social-security/questions-answers/social-security-start-at-62.html
  4. https://www.fidelity.com/viewpoints/retirement/social-security-at-62
  5. https://www.fool.com/retirement/2021/04/05/3-great-reasons-to-take-social-security-benefits-a/
  6. https://communications.fidelity.com/pi/calculators/social-security/#sectionAge
  7. https://www.ssa.gov/OACT/quickcalc/early_late.html
  8. https://www.socialsecurityintelligence.com/5-smart-reasons-to-consider-filing-for-social-security-at-62/

Tax Planning

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“It may feel good at tax time to get a refund, but remember that the money you’re getting back is money you loaned the government at no interest.”

Benjamin Franklin famously said, “nothing is certain but death and taxes.” Skip filing your taxes, and the tax agents will come calling. And when they do, you’ll likely face penalties and interest — and even lose your chance to receive a tax refund.

Unless your income is below a certain level, you will have to file federal income tax returns and pay taxes each year. Therefore, it’s important to understand your obligations and the way in which taxes are calculated.

Every year, everyone who makes money in the U.S. must fill out a prior calendar year tax return and file it with the IRS by April 15th. The process inspires dread among anyone who performs this task without the help of an accountant. The forms are complicated, and the definitions of terms like “dependent” and “exemption” can be difficult to understand.

Tax Basics and Taxable Income

There are two types of income subject to taxation: earned income and unearned income. Earned income includes:

  • Salary
  • Wages
  • Tips
  • Commissions
  • Bonuses
  • Unemployment benefits
  • Sick pay
  • Some noncash fringe benefits

Taxable unearned income includes:

  • Interest
  • Dividends
  • Profit from the sale of assets
  • Business and farm income
  • Rents
  • Royalties
  • Gambling winnings
  • Alimony

It is possible to reduce taxable income by contributing to a retirement account like a 401(k) or an IRA.

A person can exclude some income from taxation by using a standard deduction amount determined by the government and a person’s filing status or by itemizing certain types of expenses. Allowable itemized expenses include mortgage interest, state and local taxes, charitable contributions, and medical expenses.

Anyone can make an honest mistake with regard to taxes, but the IRS can be quite strict. And since everyone’s tax situation is a little different, you may have questions.

Allowed Deductions – Deductions and Tax Exemptions

The IRS offers Americans a variety of tax credits and deductions that can legally reduce how much you’ll owe. All Americans should know what deductions and credits they’re eligible for — not knowing is like leaving money on the table.

Most people take the standard deduction available to them when filing taxes to avoid providing proof of all of the purchases they’ve made throughout the year. Besides, itemized deductions often don’t add up to more than the standard deduction.

But if you’ve made substantial payments for mortgage interest, property taxes, medical expenses, local and state taxes or have made major charitable contributions, it could be worth it to take this step. These tax deductions are subtracted from your adjusted gross income, which reduces your taxable income.

The government allows the deduction of some types of expenses from a person’s adjusted gross income, or gross income minus adjustments. A person can exclude some income from taxation by using a standard deduction amount determined by the government and a person’s filing status or by itemizing certain types of expenses. Allowable itemized expenses include mortgage interest, a capped amount of state and local taxes, charitable contributions, and medical expenses.

Depending on who you are and what you do, you may be eligible for any number of tax deductions and exemptions to reduce your taxable income. At the end of the day, these could have a significant impact on your tax exposure. Starting with the standard deduction, the links below will help you determine how to shrink your income — for tax purposes, of course.

Common Tax Credits

Tax credits are also another way to reduce your tax exposure and possibly obtain a tax refund when the dust settles. Many people don’t realize that a tax credit is the equivalent of free money. Tax deductions reduce the amount of taxable income you can claim, and tax credits reduce the tax you owe and, in many cases, result in a nice refund.

The IRS offers a large number of tax credits that encompass everything from buying energy-efficient products for your home to health insurance premium payments to being in a low- to moderate-income household. The key to benefiting from these credits is examining all of the purchases you’ve made throughout the year to see if you are owed money.

There are 17 tax credits for individuals you can take advantage of in five categories:

  • Education credits
  • Family tax credits
  • Healthcare credits
  • Homeownership and real estate credits
  • Income and savings credits

Taxes: What to Pay and When

Most Americans don’t look forward to tax season. But the refund that a majority of taxpayers get can make the tedious process of tax filing worth the effort.

When you’re an employee, it’s your employer’s responsibility to withhold federal, state, and any local income taxes and send that withholding to the IRS, state, and locality. Those payments to the IRS are your prepayments on your expected tax liability when you file your tax return. Your Form W-2 has the withholding information for the year.

The U.S. has a pay-as-you-go taxation system. Just as income tax is withheld from employees every pay period and sent to the IRS, the estimated tax paid quarterly helps the government maintain a reliable schedule of income. It also protects you from having to cough up all the dough at once.

When you file, if you prepaid more than you owe, you get some back. If you prepaid too little, you have to make up the difference and pay more. And, if you’re like most wage earners, you get a nice refund at tax time.

But if you are self-employed, or if you have income other than your salary, you may need to pay estimated taxes each quarter to square your tax bill with Uncle Sam. You may owe estimated taxes if you receive income that isn’t subject to withholding, such as:

  • Interest income
  • Dividends
  • Gains from sales of stock or other assets
  • Earnings from a business
  • Alimony that is taxable

So, it’s important to remember that taxes are a pay-as-you-go. This means that you need to pay most of your tax during the year, as you receive income, rather than paying at the end of the year.

There are two ways to pay tax:

  • Withholding from your pay, your pension or certain government payments, such as Social Security.
  • Making quarterly estimated tax payments during the year.

This will help you avoid a surprise tax bill when you file your return. If you want to avoid a large tax bill, you may need to change your withholding. Changes in your life, such as marriage, divorce, working a second job, running a side business or receiving any other income without withholding can affect the amount of tax you owe.

And if you work as an employee, you don’t have to make estimated tax payments if you have more tax withheld from your paycheck. This may be an option if you also have a side job or a part-time business.

It may feel good at tax time to get a refund, but remember that the money you’re getting back is money you loaned the government at no interest.

References:

  1. https://www.nerdwallet.com/article/taxes/tax-planning
  2. https://www.findlaw.com/tax/federal-taxes/filing-taxes.html
  3. https://www.findlaw.com/tax/federal-taxes/tax-basics-a-beginners-guide-to-taxes.html
  4. https://turbotax.intuit.com/tax-tips/small-business-taxes/estimated-taxes-how-to-determine-what-to-pay-and-when/L3OPIbJNw
  5. https://www.moneycrashers.com/paying-estimated-tax-payments-online-irs
  6. https://www.irs.gov/payments/pay-as-you-go-so-you-wont-owe-a-guide-to-withholding-estimated-taxes-and-ways-to-avoid-the-estimated-tax-penalty

Taxes Strategies in Retirement

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“Taxes in retirement will likely be lower than you expect and not all your retirement income is taxable.”

Managing taxes in retirement can be complex. Yet, thoughtful planning may help reduce the tax burden for you and your heirs. By formulating a tax-efficient investment and distribution strategy, retirees may keep more of their hard-earned assets for themselves and their heirs.

The inconvenient truth is that you’ll continue to pay taxes in retirement, which in most cases will be typically at a lower effective tax rate. And, there are a variety of reasons why your tax rate in retirement will be lower.

When you’re working, the bulk of your income is earned from your job and is fully taxable (after deductions and exemptions) at ordinary income tax rates.

When you’re retired, different tax rules can apply to each type of income you receive. You should know how each income source shows up on your tax return in order to estimate and minimize your taxes in retirement.

In retirement, only pension income, withdrawals from taxable retirement accounts such as 401(k), and any rental, business, and wage income you have is taxable at ordinary income tax rates.

Withdrawals from tax-deferred retirement accounts are taxed at ordinary income rates. These are long-term assets, but withdrawals aren’t taxed at long-term capital gains rates. IRA withdrawals, as well as withdrawals from 401(k) plans, 403(b) plans, and 457 plans, are reported on your tax return as taxable income.

Social Security is taxed at ordinary income rates, but only part of it is taxable.

You probably won’t pay any taxes in retirement if Social Security benefits are your only source of income, but a portion of your benefits will likely be taxed if you have other sources of income. The taxable amount—anywhere from zero to 85%—depends on how much other income you have in addition to Social Security.

Withdrawals from Roth accounts are tax-free if you’ve had the account for at least 5 years and are over age 59 1/2.

Accessing the principal from savings and investments is tax-free and long-term capital gains are taxed at lower rates or can even reduce other taxes if you’re selling at a loss.

You’ll pay taxes on dividends, interest income, or capital gains from investments. These types of investment income are reported on a 1099 tax form each year. Each sale of an asset will generate a long- or short-term capital gain or loss, and is reported on your tax return. Short term capital gains are taxed as ordinary income and long term gains are taxed at lower capital gains tax rate.

Tax rate: Marginal vs. Effective

Marginal tax rate is the tax rate you pay on an additional dollar of income. The reason is because the next dollar that you contribute to your retirement account would normally be taxed at the marginal tax rate.

For example, a single person with a taxable income of $50k would have a 22% marginal tax bracket for 2021. But according calculations, the effective tax rate would be 13.5% of taxable income since only taxable income over $40,525, or $9,475, would be taxed at that 22%.

When you take funds out of your 401(k) in retirement, some of your income won’t be taxed at all because of deductions and exemptions. In fact, your standard deduction would be $1,700 higher if you were age 65 or older this year.

The first $9,950 of taxable income would only be taxed at 10%. Then the next bucket of income up to $40,525 would be taxed at 12%. Only the income over $40,525 would be taxed at the 22% rate.

Ideally, you want to use the lower effective tax rate when you’re estimating how much of your retirement income will go to pay taxes.

Tax strategies

Less taxing investments

Municipal bonds, or “munis,” have long been appreciated by retirees seeking a haven from taxes and stock market volatility. In general, the interest paid on municipal bonds is exempt from federal income tax and sometimes state and local taxes as well. The higher your tax bracket, the more you may benefit from investing in munis.

Also, tax-managed mutual funds may be a consideration. Managers of these funds pursue tax efficiency by employing a number of strategies. For instance, they might limit the number of times they trade investments within a fund or sell securities at a loss to offset portfolio gains. Equity index funds may also be more tax efficient than actively managed stock funds due to a potentially lower investment turnover rate.

It’s also important to review which types of securities are held in taxable versus tax-deferred accounts. Because the maximum federal tax rate on some dividend-producing investments and long-term capital gains is 20%.

Securities to tap first

Another major decision facing retirees is when to liquidate various types of assets. The advantage of holding on to tax-deferred investments is that they compound on a before-tax basis and therefore have greater earning potential than their taxable counterparts.

On the other hand, you’ll need to consider that qualified withdrawals from tax-deferred investments are taxed at ordinary federal income tax rates of up to 37%, while distributions — in the form of capital gains or dividends — from investments in taxable accounts are taxed at a maximum 20%. Capital gains on investments held for one year or less are taxed at regular income tax rates.)

For this reason, it potentially could be beneficial to hold securities in taxable accounts long enough to qualify for the favorable long-term rate. And, when choosing between tapping capital gains versus dividends, long-term capital gains may be a consideration from an estate planning perspective because you could get a step-up in basis on appreciated assets at death.

It may also make sense to consider taking a long term view with regard to tapping tax-deferred accounts. Keep in mind, however, the deadline for taking annual required minimum distributions (RMDs).

The ins and outs of RMDs

Generally, the IRS mandates that you begin taking an annual RMD from traditional individual retirement accounts (IRAs) and employer-sponsored retirement plans after you reach age 72.

The premise behind the RMD rule is simple — the longer you are expected to live, the less the IRS requires you to withdraw (and pay taxes on) each year.

In most cases, RMDs are based on a uniform table based on the participant’s age. Failure to take the RMD can result in an additional tax equal to 50% of the difference between the required minimum distribution and the actual amount distributed during the calendar year. Tip: If you’ll be pushed into a higher tax bracket at age 72.

Estate planning and gifting

There are various ways to reduce the burden of taxes on your beneficiaries. Careful selection of beneficiaries of your retirement accounts is one example. If you do not name a beneficiary of your retirement account, the assets in the account could become distributable to your estate. Your estate or its beneficiaries may be required to take RMDs on a faster schedule (such as over five years) than what would otherwise have been required (such as ten years or over the remaining lifetime of an individual beneficiary). In most cases, naming a spouse as a beneficiary is ideal because a surviving spouse has several options that aren’t available to other beneficiaries, such as rolling over your retirement account into the spouse’s own account and taking RMDs based on the surviving spouse’s own age

Key takeaways

“Nothing in life is certain except death and taxes.” Benjamin Franklin

When it comes to investing, nothing is certain but taxes.

  • Taxation and rates varies depending on the type of retirement income you receive.
  • You may pay taxes on Social Security benefits if you have other sources of income.
  • Income from pensions, traditional IRAs, 401(k)s, and similar plans are taxed as ordinary income.
  • You’ll pay taxes on investment income, including capital gains taxes if applicable.
  • Know and calculate your effective tax rate, which in most cases, will be lower than your marginal tax rate.

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Strategies for making the most of your money and reducing taxes in retirement are complex. Plan ahead and consider meeting with a competent tax advisor, an estate attorney, and a financial professional to help you sort through your options.

References:

  1. https://www.merrilledge.com/article/tax-strategies-for-retirees
  2. https://www.fidelity.com/insights/retirement/lower-taxes-retirement
  3. https://www.thebalance.com/taxes-in-retirement-how-much-will-you-pay-2388987