Non-Qualified Deferred Compensation Plans Explained

Contributed by: Kali Hassinger, CFP®, CDFA®

Contributed by: Angela Palacios, CFP®, AIF®

Deferred Compensation plans can be a powerful tool to control income tax burden in a corporate executive’s highest-earning years. However, there are many trip hazards to be aware of when starting to contribute.

What is a deferred compensation plan, and who is it appropriate for?

A Non-Qualified Deferred Compensation Plan (NQDC) is a benefit plan offered by some employers to their higher-earning or ranking employees. It is exactly what it sounds like, a plan to defer compensation today to a future date.

This is advantageous to an employee who:

• Is expecting to be in a high tax bracket now.

• Is already fully funding their retirement savings plan(s).

• Has a surplus in cash flow.

• May foresee a time when their taxable income will be reduced.

What has to be decided upon ahead of time?

The employee and employer agree upon a salary amount or bonus to set aside. They will also select a date in the future to pay the employee their earned income. Both parties agree to when the funds will be received in the future, and it isn’t taxable income until the employee actually receives it.

Most employers require you to select your payout schedule (i.e., lump sum or spread out over 15 years) when you choose to defer a portion of your income. This can be a daunting choice because you may not know exactly when you will retire, what tax rates will be, or where you will live (impacting state taxes paid on the income) at the time you retire. Often, the employer allows you time when you can change this (usually about a year before you retire), but sometimes there are rules around this change. It is important to talk to your plan administrator or HR department to understand this more fully.

One large company provides an excellent example of a complicated change policy for their corporate plan. In this instance, you may change the number of years you spread payments of your deferred income, but you must do this 12 months before you start taking the payments (12 months before retiring). Additionally, you can only extend the payment terms, which delays the start of your payments by five years! See what we mean by potentially complicated?

What are the benefits of participating in a deferred compensation plan?

• Deferring potential tax liability to a time when you may be in a lower tax bracket can provide tax savings.

• Balance can be invested in a diversified portfolio to potentially grow tax-deferred compensation over many years.

• It can provide a paycheck during a portion of your retirement.

• The company may choose to match your contributions for an added benefit.

• You may choose to retire in a state with lower or even no income taxes.

What are the potential drawbacks of participating in a deferred compensation plan?

• Usually, no access to the funds before agreed-upon terms.

• If you lose your job earlier than anticipated, you may be forced to take the total amount in a lump sum all at once, causing it to be possibly taxed in the highest tax bracket possible.

• It cannot be rolled into an IRA.

• Risk of forfeiture if the company goes bankrupt as the money isn’t explicitly set aside for the employee in most cases.

• You may not have an option to change the payout schedule before retiring, and you may get the money either faster or slower than desired in retirement.

It is helpful to have a financial plan during the years when you are eligible to contribute to one. Mapping out possible retirement dates and planning appropriate payout timelines will be important for years leading into retirement, as your options may be limited if you wait until closer to retirement to start planning. This is where a financial planning professional can help! Don’t hesitate to reach out for more information!

Kali Hassinger, CFP®, CDFA®, is a CERTIFIED FINANCIAL PLANNER™ professional at Center for Financial Planning, Inc.® She has more than a decade of financial planning and insurance industry experience.

Angela Palacios, CFP®, AIF®, is a partner and Director of Investments at Center for Financial Planning, Inc.® She chairs The Center Investment Committee and pens a quarterly Investment Commentary.

How the Build Back Better Bill Could Affect You

Contributed by: Kali Hassinger, CFP®, CDFA®

While the House just passed along the $1.2 Trillion infrastructure bill to President Biden, the final version of the Build Back Better bill is still in question. The Center has been actively monitoring this bill and how it could affect our clients’ financial lives for the last several months. Throughout that time, the contents of the bill have significantly evolved. Initially, the proposed bill seemed to include many changes that would meaningfully impact tax and income planning for many clients. Then, it seemed as though all of the individual tax consequences were off the table. Now, some of those tax features are back with, perhaps, a middle ground. Some of the highlights are outlined below, but keep in mind that this version is still up for debate and revision until this bill becomes a law!

Changes to Retirement Account Rules

- Back-door Roth IRA contributions would no longer be available. This strategy used to fund a Roth IRA, even if your income phases an individual out of the ability to make a direct Roth IRA contribution. This would no longer be available with the Build Back Better bill, but it could only affect those considered “high-income,” or defined as income above $400,000. If this is included in the final bill, great clarity can be expected on who this will impact.

- Eliminating the ability to convert after-tax 401(k) and employer retirement plan contributions to a Roth IRA.

- New contribution limits for IRA and defined contribution retirement accounts based on the account balance.  

• Right now, the ability to make an IRA, Roth IRA, or employer retirement plan contribution is not associated with the size of the account. Under the Build Back Better bill, account holders with retirement account balances exceeding $10 million (as of the end of the prior year) would not be able to contribute. If contributions are made, or a contribution causes the account to breach that $10 million level, a 6% excise tax would be imposed. In order to assist in tracking this kind of requirement, employers would be required to report participants with account balances above $2.5 million.

- Increase in required minimum distributions for “high-income” taxpayers whose accounts surpass that $10 million limit.

• It seems as if 50% of the account balance above the $10 million thresholds would need to be withdrawn. So, if you have an $11 million IRA, you would be forced to take a $500,000 withdrawal as a required minimum distribution. Failure to complete the required minimum distribution would result in a 50% excise tax on any amount not taken.

State and Local Income Tax Deduction Cap

- The current State and Local Income tax deduction is limited to $10,000 per year. The Build Back Better bill would increase this limit to $80,000 per year.

Surcharge on High-Income Individuals, Trusts, and Estate

- For individuals, a 5% surcharge would be imposed on those with modified adjusted gross income in excess of $10 million, with an additional 3% surcharge on income above $25 million.

- For trusts and estates, the 5% surcharge would be imposed on modified adjusted gross income above $200,000, with an additional 3% surcharge on income above the $500,000 level.

The Build Back Better bill would also continue the expanded Child Tax Credit into 2022 and provide additional tax credits for those who purchase electric vehicles. Although these items are still up for debate and could change drastically before being implemented, we are staying on top of these revisions as they occur.

Kali Hassinger, CFP®, CDFA®, is a CERTIFIED FINANCIAL PLANNER™ professional at Center for Financial Planning, Inc.® She has more than a decade of financial planning and insurance industry experience.

The information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation.

Matt Trujillo Captains The Center’s First Corporate Chess Team

Contributed by: Matt Trujillo, CFP®

October 7th marked the first day of the North American Corporate Chess League (NACCL). The league is relatively new, coming into existence in 2019, but has grown quite rapidly and expanded to 35 total teams this year for Season 3. This is the Center for Financial Planning’s first year competing in the league, and I’m pleased to report that we started off with a bang! 

To summarize the format, you play two games every week. The games are played at www.lichess.org and last approximately 30 minutes each. The pairing software for the league takes your chess rating and pairs you against an opponent from another team that is right around the same rating as you are. So, leading up to the games, you have no idea what team you’ll be paired against!

The team currently consists of 9 players of all strengths, with yours truly, Matt Trujillo, as the captain and first board (top-rated player). Week 1 saw us paired up against many different opponents, but a few notable names were Deloitte, Qualcomm, Peloton, AIRBNB, LendingTree.com, and SIG (Season 1 champions). There were some nerves on all sides, but the team still scored some nice wins. We ended the evening with a total score of 5 out of 8 possible wins and tied for 18th out of 35th overall. 

I’m looking forward to the rest of the season. The goal is to climb the leader board and break into the top 10, but the biggest goal is to have some fun and introduce new people to competitive tournament chess!

Matthew Trujillo, CFP®, is a CERTIFIED FINANCIAL PLANNER™ professional at Center for Financial Planning, Inc.® A frequent blog contributor on topics related to financial planning and investment, he has more than a decade of industry experience.

Reviewing your Social Security Benefit Statement

Contributed by: Nick Defenthaler, CFP®, RICP®

According to the Social Security Administration, on average, Social Security will replace about 40% of one’s pre‐retirement earnings. Given the diligent savings and consistently wise financial decisions many of our clients at The Center have made over the years, this percentage might not be quite as high. However, in our experience, Social Security is still a vital component of one’s retirement plan. Let’s review some of the important aspects of benefit statements to ensure you’re feeling confident about your future retirement income.

History of Mailed Statements

In 1999, the Social Security Administration (SSA) began mailing paper copies of Social Security statements to most American workers. Since that time, through several budget reduction initiatives, this process has dramatically changed. As we stand here today, no worker under the age of 60 receives a projected benefit statement by mail. Only those who receive statements by mail are both 60 and older and have not yet registered for an online SSA account.

Online Access – The “my Social Security” Platform

I have to hand it to Social Security – they’ve done a fantastic job, in my opinion, by creating a very user-friendly and easy‐to‐follow online platform to view benefit statements and projections. To create a user account or to sign in to your existing account, click here. If you have not set your account up and wish to do so, you’ll be prompted to provide some basic personal identifiable information such as your name, Social Security number, date of birth, address, e‐mail address, etc. The SSA has also made several great cyber security improvements, including dual‐factor authentication and a photo of a state‐issued photo ID, such as a driver’s license, to verify identification. This is similar to a mobile check deposit that many banks now offer on a smartphone.

Interpreting your Projected Future Income

Benefit projections at various ages can be found on page 2 of your Social Security statement. As you’ve likely heard your advisor share in the past, each year you delay benefits, you’ll see close to an 8% permanent increase on your income stream. Considering our low‐interest‐rate environment and historically high cost of retirement income, this guaranteed increase is highly attractive. It’s important to note that estimated benefits are shown on your statement in today’s dollars and do not take inflation into account. That said, the latest 2020 annual reports from SSA and Medicare Boards of Trustees use 2.4% as an expected future annual inflation amount. Click here to learn more about the sizeable cost of living adjustment in 2022 for those currently receiving Social Security. You should also be aware that Social Security assumes your current earnings continue until “retirement age,” which is not necessarily the same as “full retirement age.” This can potentially be a significant issue for those retiring earlier (i.e., before age 60 in most cases). Click here to learn more about how your income benefits are determined.

Earnings History and Fixing Errors

Page 3 of your Social Security statement details the earnings that the SSA has on file for each year since an individual began working. Believe it or not, SSA does make mistakes! Our team makes it a best practice to review a client’s earnings history on the statement to see if there are any significant outlier years. In most cases, there’s a good reason for an outlier year with income, but it’s simply an error in others. If you do notice an error with your earnings that needs to be fixed to ensure it does not negatively impact your future Social Security benefit, you have a few options. Once supporting documentation is gathered (i.e., old tax returns, W2s, etc.), you can contact the SSA by phone (800‐722‐1213), visit a local SSA office, or complete Form SSA-7008.

Believe it or not, in some circumstances depending on filing strategies, one can generate as much as $1M in total lifetime benefits from Social Security! If you have yet to file, however, there’s a good chance it’s been a bit since you’ve reviewed your benefit statement. If our team can help interpret your benefit statements, please feel free to reach out. The stakes are too high with Social Security, and we are here to help you in any way we can!

Nick Defenthaler, CFP®, RICP®, is a Partner and CERTIFIED FINANCIAL PLANNER™ professional at Center for Financial Planning, Inc.® Nick specializes in tax-efficient retirement income and distribution planning for clients and serves as a trusted source for local and national media publications, including WXYZ, PBS, CNBC, MSN Money, Financial Planning Magazine and OnWallStreet.com.

Raymond James and its advisors do not offer tax advice. You should discuss any tax matters with the appropriate professional. The information has been obtained from sources considered reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Nick Defenthaler, CFP®, RICP®, and not necessarily those of Raymond James. Every Investor’s situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment, Prior to making an investment decision, please consult with your financial advisor about your individual situation.

Inflation Hedges Explored

Contributed by: Nicholas Boguth, CFA®

Our Director of Investments, Angela Palacios, recently wrote about the factors influencing current inflation rates. She shared a helpful chart from JPMorgan and summarized, “you may be surprised to see the strong average performance from varying asset classes in this scenario. Inflation that is reasonable and expected can be a very positive scenario for many asset classes.”

As the debate continues over whether or not inflation is “transitory,” some investors are thinking about how to protect their portfolios from rising inflation.

Most bonds, aside from TIPS, are generally expected to perform poorly if inflation rises. This should make sense as the fixed income stream from a bond investment will deteriorate if inflation rises. To protect against inflation, one might conclude that removing bonds from a portfolio makes sense, but not so fast. Bonds are typically in a diversified portfolio to protect from the more common (and devastating) risk – a stock market decline. Be sure to know how your portfolio’s risk exposure would shift before considering a move away from bonds.

Vanguard recently released some research on the topic of inflation hedging and concluded that commodities were the best asset class to protect from unexpected inflation. While commodities are generally accepted to be pretty good inflation hedges, one major risk of owning them has been on display for the past ten years. Their return stream can look significantly different than stocks’. Admittedly, this has been one of the best decades in history for U.S. stocks and one of the worst for commodities. To demonstrate just how “different” the returns can be, if you would’ve held one of the largest commodity ETFs over the past ten years, you would’ve underperformed the U.S. stock market by almost 400%.

Trailing 10-year performance of two ETFs that represent the U.S. stock market and the broad commodities market. SPY (green line) tracks the S&P 500, and DBC (blue line) tracks a basket of 14 commodities. Total return. Source: koyfin.com.

Some portfolio managers like Ray Dalio or First Eagle portfolio managers, Matthew McLennan and Kimball Brooker, have been long time proponents of gold as a hedge against inflation. Gold can be a powerful diversifier in a portfolio, but has also seen sustained periods of underperformance that may make it hard to hold over the long term. Here’s a similar chart of how a popular Gold ETF has performed over the past ten years compared to the red hot S&P 500.

Trailing 10-year performance of two ETFs that represent the U.S. stock market and the price of Gold. SPY (green line) tracks the S&P 500, and GLD (blue line) tracks the gold spot price. Total return. Source: koyfin.com.

You may even see articles claiming that bitcoin is the best inflation hedge to add to your portfolio. These opinion pieces make some compelling arguments, but it is important to remember that they are just opinion pieces; emphasis on opinion. We haven’t truly had an inflationary period since bitcoin became popular in the past decade, so there is no way of knowing if its performance has any correlation to U.S. inflation.

Above all else, before jumping to action on your portfolio, remember that inflation is quite hard to forecast. There are an infinite amount of moving parts and multiple ways to measure them. Professional forecasters don’t even agree on what it will look like in the next 12 months, let alone the next ten years or the remainder of your investment time horizon. One of the best ways to hedge against inflation is to talk to your financial advisor and understand how rising inflation might affect your financial plan. That is why we’re here.

Want to know what The Center thinks about inflation? Check out these resources: Inflation and Stock Returns and How Do I Prepare my Portfolio for Inflation.

Nicholas Boguth, CFA® is a Portfolio Administrator at Center for Financial Planning, Inc.® He performs investment research and assists with the management of client portfolios.

Opinions expressed are not necessarily those of Raymond James. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Past performance is not a guarantee of future results. Investing involves risk and investors may incur a profit or a loss. Treasury Inflation Protection Securities, or TIPS, adjust the invested principal base by the CPI-U at a semiannual rate. Rate of inflation is based on the CPI-U, which has a three-month lag. Bond prices and yields are subject to change based upon market conditions and availability. If bonds are sold prior to maturity, you may receive more or less than your initial investment. There is an inverse relationship between interest rate movements and fixed income prices. Generally, when interest rates rise, fixed income prices fall and when interest rates fall, fixed income prices rise. Investing in commodities is generally considered speculative because of the significant potential for investment loss. Their markets are likely to be volatile and there may be sharp price fluctuations even during periods when prices overall are rising. Gold is subject to the special risks associated with investing in precious metals, including but not limited to: price may be subject to wide fluctuation; the market is relatively limited; the sources are concentrated in countries that have the potential for instability; and the market is unregulated. Bitcoin issuers are not registered with the SEC, and the bitcoin marketplace is currently unregulated. Bitcoin and other cryptocurrencies are a very speculative investment and involves a high degree of risk.

Center Participates in Annual Walk to End Alzheimer’s

Contributed by: Center for Financial Planning, Inc.®

Center Team members recently participated in the Walk to End Alzheimer’s in Brighton. The walk, sponsored by the Alzheimer’s Association of Michigan, raised funds and awareness for dementia, a disease that has and continues to impact our clients, client’s families, and team member’s families. Alzheimer’s and other dementias impact those diagnosed and their families so significantly from a psychological, emotional, and financial standpoint that we make substantial efforts at The Center to provide extra information, resources, and support to clients who may be impacted. Helping to raise awareness and funds for research is just one of the things we do!

If a client or family member were to receive a dementia diagnosis, we have helpful resources and action steps available here:

How to Reduce the Risks of Dementia and Diminished Capacity to Your Retirement Plan

A Dementia Diagnosis and Your Financial Plan

The Center Supports “Swing Fore the Cure” Golf Outing

Contributed by: Nicholas Boguth, CFA®

The Center was proud to sponsor the "Swing Fore the Cure" golf outing, a fantastic event involving raising money for a worthy cause and having a great time while doing it! The outing was organized by the family of the Center’s own, Nick Boguth, whose mother has been a significant fundraiser for the cause since becoming a breast cancer survivor 15 years ago.

Cancer is something that hits close to home for most of us as we all have colleagues, family, or friends who have been affected by the disease. The Center was happy to corral around this event, bring some of our Center energy to the golf course, and support the fundraising efforts that benefitted Ascension St. John Breast Cancer Center, Wigs 4 Kids, and Susan G. Komen Foundation.

Nicholas Boguth, CFA® is a Portfolio Administrator at Center for Financial Planning, Inc.® He performs investment research and assists with the management of client portfolios.

Social Security Cost of Living Adjustment & Wage Base for 2021

Contributed by: Kali Hassinger, CFP®, CDFA®

It has recently been announced that Social Security benefits for millions of Americans will increase by 5.9% beginning January 2022. This is the largest cost of living adjustment in 40 years! The increase is calculated based on data from the Consumer Price Index for Urban Wage Earners and Clerical Workers, or CPI-W, from October 1st, 2020 through September 30th, 2021. Inflation has been a point of concern and received a great deal of media attention this year, so this increase comes as welcome news for Social Security recipients who have received minimal or no benefit increase in recent years.

The Social Security taxable wage base will also increase in 2022 from $142,800 to $147,000. This means that employees will pay 6.2% of Social Security tax on the first $147,000 earned, which translates to $9,114 of Social Security tax. Employers match the employee amount with an equal contribution. The Medicare tax remains at 1.45% on all income, with an additional .9% surtax for individuals earning over $200,000 and married couples filing jointly who earn over $250,000.

For many, Social Security is one of the only forms of guaranteed fixed income that will rise over the course of retirement. However, the Senior Citizens League estimates that Social Security benefits have lost approximately 33% of their buying power since the year 2000. This is why, when working to run retirement spending and safety projections, we factor an erosion of Social Security’s purchasing power into our clients’ financial plans.

Kali Hassinger, CFP®, CDFA®, is a CERTIFIED FINANCIAL PLANNER™ professional at Center for Financial Planning, Inc.® She has more than a decade of financial planning and insurance industry experience.

2021 Third Quarter Investment Commentary

Contributed by: Center Investment Department

Crisp Air, Cool Breeze, Fall Leaves. All the things that Autumn brings here in Michigan. As the third quarter comes to a close and we enter the last quarter of 2021, we find a cool breeze passing through markets as volatility picks up - as is often the case in September and October. A diversified benchmark portfolio consisting of 60% stocks (split between U.S.-S&P 500 and International-MSCI EAFE) and 40% bonds (Bloomberg Barclays U.S. Aggregate Bond Index) is up just over 7% year-to-date as of September 30th, with the S&P 500 leading the way at +15.9%, international stocks (MSCI EAFE) at +8.35%, and U.S. Aggregate Bonds at -1.55%.

Check out this video to recap some of our thoughts this quarter and continue to read below for some more detailed insight!

Volatility has picked up as the recovery appears to be in a holding pattern. Investors worry about the delta strain and are concerned about a surge in additional strains that could come with the winter flu season. Stock markets don’t have a clear driver of upward returns right now, and we are currently in the middle of two of the most challenging months (September and October) of the year historically for markets. Until September, the S&P 500 hadn’t experienced a 5% decline (which usually occurs 2-4 times per year) since October 2020. The market broke this long streak in late September. Headlines from the government, worry about bonds rates increasing, Chinese real estate headlines, and inflation fears have caused a pause in the steady upside we all had grown quite comfortable to!

It’s important to remember markets frequently experience short-term pullbacks. The below chart shows intra-year stock market declines (red dot and number), as well as the market’s return for the full year (gray bar). This chart shows us that the market is capable of recovering from intra-year drops and still finishing the year in positive territory, which helps us remember to stay the course even when markets get choppy!

Fed Tapering – Will It Cause Volatility?

Google searches on tapering peaked in late August and again in late September surrounding the Federal Reserve (the Fed) meeting. The Fed has fully telegraphed their intention to make this move that, likely, isn’t starting until late this year. It’s important to remember that tapering isn’t tightening. The Fed is lessening the rate they are buying government bonds. Investors wonder, “Will interest rates spike when they stop buying so much?” The answer is maybe. However, there won’t be as much debt being issued next year without fiscal stimulus as has been in the past year and a half. So, current buyers other than the Fed should be able to absorb supply. Also, U.S. Treasury bonds are still paying much more than other government’s bonds that are similar in quality. If rates go up, they will likely be met with headwinds because pension funds and other governments will want that increased yield buying the bonds and thus forcing rates back down again.

Over the summer, the Fed started to unwind the secondary market corporate credit facility that was announced early on in the pandemic to support corporate bonds and fixed income exchange-traded funds. The Fed’s holdings peaked at $14.2 Billion as the move quickly restored stability in markets at the time – March 2020 - and no further action was needed. They are planning the sales in an orderly fashion as not to disrupt markets.

Washington D.C. – A Game of Political Chicken

There have been a lot of headlines toward the end of the third quarter from the government, including government shutdown possibility, reconciliation, infrastructure bill, debt limit increase, and tax increase plans. 

First, the temporary funding bill and debt limit caused short-term volatility as investors were nervous that politicians not seeing eye-to-eye would cause another government shutdown or worse - default on U.S. debt. Fortunately, the President signed a bill funding the government through December 3rd, just hours before the deadline. You may not realize how often we have stood at this precipice before, though. According to the Congressional Research Service and MFS, “There have been 21 government shutdowns in history when our nation’s lawmakers failed to agree on spending bills to fund government outlays for a fiscal year that begins annually on October 1st. The most recent shutdown, a 35-day stoppage that ended on 1/25/19, was the longest closure in history. 11 of the 21 shutdowns lasted three days or less.” Interestingly enough, there are many similarities between now and 2013 when the FED was rolling out their plan for tapering, debt ceiling debate, and government shutdown. While what happened in the past isn’t necessarily what is going to happen now, we believe it offers a helpful perspective. You can see that in 2013 there was an uptick in volatility and a short-term market retreat, but overall the markets continued to move higher through year-end.

Source: Raymond James Chief Investment Officer, Larry Adam

In September, we gained some clarity on the tax increase proposals to assist in paying for the infrastructure bill. Check out our blog on some of the details, as well as our upcoming webinar! Capital gains tax proposals can potentially disrupt markets in the near term, but the increase in those taxes would go into effect as of mid-September 2021 (retroactively). This is important because it prevents a rush of selling to harvest capital gains before an effective date.

China Headlines

Why has China and emerging markets lagged recently? China is the 2nd biggest economy in the world and the 2nd biggest equity market in the world. China represents 35% of the Emerging Market index, so when China lags, the entire asset class tends to lag too. Active management can be important in this area to navigate the complexities of these varying countries. China has shifted gears recently, choosing to focus on social stability (or “Common prosperity”) rather than pure growth as in the past. China’s Communist Party has turned its eye to the ultra-wealthy, politically outspoken citizens and technology usage.

Most alarmingly, however, has been Evergrande’s debt woes. Evergrande is one of China’s largest real estate developers with a massive amount of debt. They have been forced to sell off assets in order to meet debt repayments, which is having a ripple effect through their customers, suppliers, competitors, and employees. This is so impactful because one-third of China’s Gross Domestic Product is related to real estate. As you can see in the chart below, housing represents over three-quarters of financial assets in China versus a much lower percentage (less than one-third) here in the U.S.

Initially, there was fear of contagion spreading from the Chinese High Yield debt market to the U.S., but this hasn’t occurred.

We remain disciplined in the consistent and proactive execution of our investment process that is anchored in the fundamentals of asset allocation, rebalancing, and patience. From time to time, we may choose to express our forward-looking opinions of the state of stock and bond markets but always strive to do so without subjecting you to unnecessary risks. Even though we close this quarterly note similarly each time, please understand that we thank you for the trust you place in us to guide you through your investment journey!

We have more thoughts to share on investment current events coming soon. Stay tuned for our investment blogs about inflation hedges and Biden’s corporate tax rate proposal.

Angela Palacios, CFP®, AIF®, is a partner and Director of Investments at Center for Financial Planning, Inc.® She chairs The Center Investment Committee and pens a quarterly Investment Commentary.

Any opinions are those of the author and not necessarily those of Raymond James. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. There is no assurance any of the trends mentioned will continue or forecasts will occur. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. The MSCI EAFE (Europe, Australasia, and Far East) is a free float-adjusted market capitalization index that is designed to measure developed market equity performance, excluding the United States & Canada. The EAFE consists of the country indices of 22 developed nations. The Bloomberg Barclays US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor's results will vary. Past performance does not guarantee future results. Diversification and asset allocation do not ensure a profit or protect against a loss. Dividends are not guaranteed and must be authorized by the company's board of directors. Special Purpose Acquisition Companies may not be suitable for all investors. Investors should be familiar with the unique characteristics, risks and return potential of SPACs, including the risk that the acquisition may not occur or that the customer's investment may decline in value even if the acquisition is completed. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Past performance is not a guarantee or a predictor of future results. Raymond James and its advisors do not offer tax or legal advice. You should discuss any tax or legal matters with the appropriate professional.

Proactive Planning Moves for an Evolving Tax Environment

Contributed by: Timothy Wyman, CFP®, JD

Contributed by: Lauren Adams, CFA®, CFP®

Just about every financial decision and transaction that we make has an income tax component or consequence. With federal marginal rates currently as high as 37%, state income tax rates as high as 13%, and additional surcharges for high-income earners, being efficient with income tax planning is paramount in accumulating or conserving wealth.  

Moreover, President Biden is planning the first major federal tax hike since 1993 that appears likely to be passed this year, at least in part. If passed, tax measures would likely take effect in 2022, with the potential for some measures to be applied retroactively even into 2021. 

At The Center, we have a long history and experience working with our clients and their tax preparers to drive down tax costs as much as possible. Our planning team may address the following for our clients’ benefit:

Marginal Tax Rate: The marginal tax rate is the tax rate paid on the next or last dollar of income. Current federal marginal rates go from 10% up to 37%. Your current, and expected future, marginal rate provides insight into decisions such as accelerating or delaying income as well as whether municipal bonds or taxable bonds are most efficient. Your marginal bracket also determines what long-term capital gains rate is applied. The current highest marginal bracket is 37% (and current proposed tax legislation could raise the upper rate to 39.6%).

Average or Effective Tax Rate: In addition to your marginal tax rate, the average rate helps us understand your overall tax picture. To determine your average rate, divide the total tax paid by your total income. For example, one might be in the 35% marginal tax bracket, but their average tax rate might be closer to 25%.

Itemized vs. Standard Deduction: Are you itemizing deductions, or does the standard deduction provide a greater benefit? With current limitations on itemized deductions, such as state & local income taxes and real estate taxes capped at $10k, many find that they no longer itemize deductions unless they “bunch.” For instance, bunching may involve grouping five years’ worth of charitable donations into one year. Many people do this by gifting to a vehicle like a Donor Advised Fund so the tax deduction may be recognized immediately, but the funds then get divvied out to charity more slowly over time. Essentially, bunching itemized deductions, such as charitable gifts, every other or few years typically provides the most efficient tax strategy.

Long Term Capital Gains: Under current law, long-term capital gains (securities held longer than 12 months) receive preferential tax rates vs. ordinary income tax rates. There are three brackets 0%, 15%, and 20%. Current proposed tax legislation could raise this rate to 25% for the highest income earners.

Carry Forward Losses: The goal of investing is to make money. One strategy to use when an individual investment loses value is to “harvest the loss.” Harvesting losses can be valuable as they offset capital gains dollar for dollar. If you have extra or additional losses, up to $3,000/year can also be used to offset ordinary income. Ideally, this harvesting of losses should be done on an ongoing basis rather than only at the end of a quarter or year.

Qualified Dividends: Qualified dividends are dividends taxed at a long-term capital gains rate instead of your ordinary income tax rate, which is generally higher. All things being equal, we would rather have dividend income that is considered qualified to achieve greater tax efficiency.  

Roth Conversion Opportunities: Sometimes paying tax today versus later is a tax-efficient strategy. If you feel that you will be in a higher bracket later, or even that your beneficiaries may be at a higher tax bracket, full or partial Roth conversions can be employed to recognize that income today at a lower rate. Roth money can be used to provide tax-free and RMD free retirement income. Having Roth dollars also provides opportunities to optimize your current marginal bracket as part of a comprehensive retirement income plan. 

IRMAA Surcharges: Our tax code contains provisions that may be described as “hidden taxes.” One such tax includes the Medicare income-related monthly adjustment amount (or IRMAA), which is an extra surcharge based on your total income (specifically Modified Adjusted Gross Income). Meaning, depending upon your income, you might pay a higher premium for Medicare (Part B and D). For example, in 2021, a joint couple pays $148.50/month when their income is less than $176k. Once you go a dollar over, the premium now becomes $220.20/month per person and is added to your Medicare premiums – a hidden tax. There are additional thresholds, and the current maximum premium for those with income over $750k is a total of $582/month each. Managing brackets by limiting or decreasing income, such as using Qualified Charitable Distributions from an IRA, can reduce your surcharge.

Net Investment Income (NII) Tax: Another so-called hidden tax applies to single taxpayers with MAGI above $200k and $250k for couples filing jointly. Investment income over these thresholds contains an additional 3.8% tax. So, while the stated maximum capital gains rate is 20%, the highest long-term capital gains rate is actually 23.8% with the surtax (before taking state taxes into account).

Phase-outs: At last count, there are over 50 tax credits that may be available to taxpayers. Unfortunately, they are subject to a variety of income phase-outs, so careful planning is required.

The Biden tax plan, if passed, contains additional income and estate tax provisions that we are closely monitoring including, but not limited to:

• New tax increases on households earning more than $400k, including upping the top tax rate to 39.6% and lowering the amount of income needed to reach that top bracket

• Increasing the top long-term capital gains rate from 20% to 25% 

• Restricting many tax and estate planning techniques, including backdoor Roth IRA conversions, the ability to convert pretax IRA dollars into Roth IRA dollars for high earners, and eliminating intentionally defective grantor trusts (a strategy used to move assets out of one’s taxable estate)

• While the Biden plan appears to exclude any “wealth tax” such as proposed by Senator Elizabeth Warren, there may be changes to estate tax provisions such as decreasing the Estate Exemption Equivalent from $11.77M per person to $5M

• Introducing and expanding additional child tax credits 

Lastly, we find that efficient tax planning considers not only your current year taxes, but a plan that considers several years or even several generations. Assuming an increase in individual (and corporate) tax rates, the stakes will be even higher and proper planning can help put more in your pocket.  

Stay tuned for an upcoming video message in November intended to keep you in the loop with proposed tax changes. Learn more about the American Families Tax Plan proposal HERE.

Timothy Wyman, CFP®, JD, Timothy Wyman, CFP®, JD, is the Managing Partner and CERTIFIED FINANCIAL PLANNER™ professional at Center for Financial Planning, Inc.® Tim earned a place on Forbes’ Best-In-State Wealth Advisors List in Michigan¹ in 2021 for the fourth consecutive year. He was also named a 2020 Financial Times 400 Top Financial Advisor² for the third consecutive year.

Lauren Adams, CFA®, CFP®, is a CERTIFIED FINANCIAL PLANNER™ professional and Director of Operations at Center for Financial Planning, Inc.® She works with clients and their families to achieve their financial planning goals and also leads the client service, marketing, finance, and human resources departments.

While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional. Unless certain criteria are met, Roth IRA owners must be 59½ or older and have held the IRA for five years before tax-free withdrawals are permitted. Additionally, each converted amount may be subject to its own five-year holding period. Converting a traditional IRA into a Roth IRA has tax implications. Investors should consult a tax advisor before deciding to do a conversion.