THREE WEEKS LEFT FOR TAX & FINANCIAL MOVES

Although December is a busy period with holiday shopping and parties, this is a pivotal period to make tax and financial decisions.  Here are a few year-end options to consider:

1.      If you sell stock at a gain this year, the tax on the gain is determined by how long you owned that stock.  Short term (one year or less) gains will be taxed at your ordinary tax rate (normally 25% or more).  The tax rate for long term gains (more than one year) will be taxed at 15% unless you are in a low tax bracket and then it will be taxed at zero percent.

 

2.      If you itemize your tax deductions, you may decide to donate some of your clothing and household goods to charities on or before December 31^st.   Most taxpayers are in the 25% marginal tax bracket or higher, so a $400 charity donation results in an extra $100 in tax refunds.   Make sure you obtain a tax receipt from the charity in case you are audited.

3.      If you have children, grandchildren, or other relatives that you want to help with their future college plans, you should consider the College 529 Plan.  There are two college plans in Maryland.  The Maryland Prepaid College Trust allows families to lock in payments at Maryland’s public colleges.  There are some restrictions with this plan, so you should research this plan carefully to determine if it meets your needs. 

 

The other College 529 plan, the College Investment Plan, is the more popular plan.  In Maryland, a taxpayer can open this plan for a beneficiary and contribute up to $2,500 per year per person.  This $2,500 contribution can be deducted on your Maryland’s tax return and will result in about $400 on your state refund for most taxpayers.   The state of Maryland has contracted with T. Rowe Price to manage the funds for this 529 Plan and there are several portfolios to choose from.  Most states have tax deductions for their 529 plans as well.

 

4.      Since the stock market has done so well in 2013, it’s difficult to predict how much further it can grow in 2014.  However, the latest government statistics show that GDP growth was up last quarter to the highest level in years and the unemployment rate dropped to 7.0% in November, which is the lowers number in years.   So the economic figures look good at this point. 

Regardless of the Dow Jones performance, my advice is that all taxpayers take advantage of IRAs, 401Ks, and TSPs because the federal and state tax benefits results in tremendous tax breaks.  For example, a $1,000 contribution will only cost you $670 after tax breaks.   So, my recommendation is to contribute as much as your employer’s matching contribution as a minimum.   If you can afford to contribute more, the maximum contribution is $17,500 for those under age 50 or $23,000 for those 50 and over.

FINANCIAL PLANNING QUIZ

1.      Your tax refund was $5,000 for 2012 and you expect the same for 2013.  Should you adjust your W-4 tax withholding form? _____________________________________

2.      You plan to buy a watch for $150.  Jeweler 1 offers a discount of 20% off and Jeweler 2 offers $25 off for the same watch.  Which one do you choose? _____________

3.      What is the Dow Jones average today? ___________________ Why should you care?

____________________________________________________________

4.      If your son received a free scholarship to George Mason University and was accepted to Harvard University with a tuition of $45,000 a year, where should he go to college? _______________________________

5.      If you buy a house and the bank offers you a $200,000 loan at 4.0% interest with 2 points or another loan at 4.5% interest with no points, which loan would you prefer? __________________________

6.      You buy a printer at Best Buy for $100 and Best Buy offers you a warranty for $29.95.  Should you accept? ___________________

7.      What percent of your income goes to taxes? __________________________

8.       What is the best age to start collecting your Social Security payments?_________________________________________

9.      If you are between 20 and 30 years old, how much of your investments should be in stocks? ________________

10.  When is the best age to start investing for retirement – 25, 35, 45, or 55? _____________________________________________________

 

THE VALUE OF 401K, 403B, and TSP

 

Senate Finance Committee Chairman Max Baucus (D-Mont.) and Ranking Member Orrin Hatch (R-Utah) have launched a process to reform America’s tax code.   They claim that everything is on the table including education credits, child credits, mortgage interest, and charitable donations.  However, one tax benefit that appears to be safe from Congress is deferred retirement breaks like the 401K, 403B and the government’s version of the 401K known as the Thrift Savings Plan or TSP.

As an Enrolled Agent who has prepared thousands of tax returns in my lifetime, I can personally attest that retirement accounts are the greatest investment that a taxpayer can make for several reasons:

1.     They have tremendous tax breaks.  A taxpayer can contribute $17,500 or $23,000 if 50 years old or over to a 401K plan and be taxed at a lower income.   For example, if your salary is $90,000 per year and you’re 50 years old, you can contribute $23,000 to your retirement account and your taxable income would only be $67,000 ($90,000 - $23,000) not counting other deductions or exemptions.  Since the person in this example is in the $25% tax bracket, the taxpayer would save $5,750 in federal taxes and another $1,955 in Maryland taxes for a total savings of $7,705.  That is a return on investment of 33.5% not counting the earnings that his money will be making in the retirement account.  How much is the bank paying you for your savings accounting or money market fund?  How much are you earning with your mutual fund?  Is it 33.5%?

2.     Fees are relatively small with a retirement fund that you contribute at work.  For example, the administrative fee for the government’s TSP fund is only .027% or 27 cents per $1,000 invested.  In comparison, mutual fund fees average about 1% or $10 per $1,000 invested. 

3.     Many companies match employees’ retirement contributions.  The government’s TSP program matches up to 5% of an employee’s salary.  According to a 2010 report from the Office of Personnel Management, 73% of employees who participated in TSP contributed enough money to quality for the maximum matching rate of 5% from the government.  Are you one of them?

4.     Most retirement funds have options for employees to choose how to allocate their funds.  TSP has several options ranging from Government securities to International funds.   We all need to monitor the performance of these funds at least quarterly so that we take advantage of performance trends.  For example, the Bond market, known as the F Fund in TSP, lost money last year due to climbing interest rates, so we need to review and adjust our allocations periodically.

Here are the rates of return for TSP in the past year:

Last         L Income      L 2020      L 2030      L 2040      L 2050     G Fund    F Fund    C Fund     S Fund

12 months   5.09%        11.66%     14.42%     16.49%     18.51%     1.44%     -.48%     20.58%     25.66%

As they say in the financial industry, past performance does not guarantee future returns.  If you are not sure which fund to invest, my advice is to select the Lifecycle or L fund for the decade that you plan to retire.  Investment experts have selected a blend of funds in the Lifecycle fund that should meet your retirement needs for the future.

Please let me know if you have any questions.

WILL CONGRESS TERMINATE FEDERAL SEQUESTRATION?

         

It is clear to me that sequestration and furloughs should end immediately for several reasons. 

1.     The FY 2013 deficit will be much lower than projected.  The April federal budget numbers are in and the federal revenue collected in April 2013 was $407B, which was a substantial increase of 28% compared to April 2012.  As a result, the revised deficit for 2013 should be about $200B less than the original forecast.  Since sequestration was projected to save $85B, it appears that tax collections this year have more than made up the required savings of sequestration. 

Below is a table of federal revenue and expenses for Fiscal Year (FY) 2013 from October, 2012 through April, 2013 in billions of dollars:

	FY 2012	FY 2013	$ Change	% Change
Revenue	1,383	1,603	220	15.9%
Expenses	2,103	2,092	(11)	-0.5%
Deficit	(720)	(489)	231	-32.1%

 

2.     Government furloughs will affect service to the public and could cause security risks.  We saw the impacts that temporary furloughs of Air Traffic Controllers had on air travel.  Meanwhile, many military leaders are concerned that sequestration will limit military training exercises and reduce military effectiveness.

 

3.     Furloughs could affect the national economy and GDP with hundreds of thousands of civilians facing a cut in pay.  In addition, some local economies that are closely tied to government spending could be severely impacted by furloughs.   

4.     Many federal government agencies have completely curtailed training, which I believe will have long-term impacts on government efficiency.  As a former government official, I have seen first-hand the benefits of training on an employee’s effectiveness, morale, and dedication to government service.  Conversely, I have seen negative impacts when training is eliminated.  In an ever-changing world, untrained employees will fall behind the technical and marketable skills required for an effective workforce.  Some agencies already have problems with huge backlogs and some are using 20^th century processes.

What about FY 2014?  Well, the stock market is at an all-time high which should drive additional tax revenues upward.  As investors sell stocks at large gains or receive dividends in 2013, incomes and federal taxes will grow considerably.  Meanwhile, the federal government is certainly headed for another Continuing Resolution (CR).  In addition, the FY 2014 CR could be longer than normal when you consider that President’s Obama’s budget was delivered to Congress two months later than required and the House and the Senate have a $91B difference in the spending gap.  Congress has rarely appropriated federal budgets by September 30^th under normal conditions and FY 2013 and FY 2014 are far from normal.

The Federal Debt on Taxes

Federal Money is Thrown Around!

Since this is my first blog, I will keep it relatively simple but I encourage comments and questions.
Federal income taxes are expected to grow next year for a couple of reasons. One, many tax breaks are due to expire next year. Two, the country cannot sustain trillion dollar losses in its budget every year. When you divide a trillion dollars by the total number of Americans, the cost per person is more than $3,000. However, if you exclude non-working Americans like retirees, students, etc, a trillion dollars is more than $6,000 per working American.
 
The federal deficit has accumulated to over $14 trillion, which is nearly the same value of the Gross Domestic Product (GDP) or all the goods and services that the United States produces in one year. Every American's share of the national deficit is currently about $42,000 and growing rapidly. In addition, the interest that is owed on the national debt is also growing rapidly - faster than the typical American's salary each year.

Unless Congress intervenes, one of the taxes due to increase on January 1, is social security tax. It will be restored to its full tax rate of 6.2%, up from the 4.2% Americans are paying this year. A 2% increase in the social security rate may not seem like much, but it could have an impact on the economy. With Americans seeing a 2% drop in their paychecks, consumer spending should be affected which in turn will affect business revenue, profits, dividends, etc. This could affect the overall economy and the anemic job market.

If you have any questions or need advice, please contact me at allaich@aol.com