Jason P. Tank, CFA

Minding the Gap Years in Retirement

January 31, 2020 by Jason P. Tank, CFA

Q: My husband and I are in our mid-60s. We are planning to retire very soon. We are having a bit of a disagreement about when we should file for our Social Security benefits. I want to wait and he wants to collect right away! Who is right?

A: Congratulations! Of course, I can’t tell you who is right without all the facts. But, I can tell you that your decision may open up interesting opportunities during the “gap years” marked by the end of your work life and the start of your Social Security. Given that you’re the one who asked the question, I have to give you the preliminary nod!

To start, most people know the advantages of delaying Social Security. The boost in benefits can be big, if you can afford to wait. That decision, of course, depends on good genes, good health and good luck, too!

Delaying Social Security not only boosts your future benefits, but it also widens the length of your “gap years” and, with it, it also opens a nice tax planning window.

First, there’s a little-known wrinkle in the tax law that’s been around for about 15 years. For people who pay tax in the 12% federal bracket, realized capital gains are afforded a special 0% federal tax rate. If you are able to live off of your already-taxed savings during your gap years, you might be able to strategically sell some of your highly-appreciated stock without taking any federal tax hit at all.

To be clear, selling that stock doesn’t mean you aren’t allowed to immediately re-buy it for your portfolio. You are just getting a tax-free shot to effectively “step-up” the cost basis to today’s price. That’s a shot that usually only happens when you die. This way is much more satisfying!

Next, you might consider doing some strategic Roth conversions during your gap years. A Roth conversion is just a fancy term for taking some of your pre-tax, regular IRA money and moving it over into a tax-free, Roth IRA. Of course, the income tax you’ll owe with any Roth conversion should always be paid with money that’s outside your regular IRA.

The main motivator for doing a Roth conversion is when your current tax rate is the same, or preferably less, than your expected future tax rate. During your gap years, when you might choose to draw down your already-taxed savings to cover your needs, you can purposely look much poorer to Uncle Sam and sneakily squeeze Roth conversions into your tax return at a temporarily low tax rate.

While recently traveling around London during a very special visit to my older brother, I got very used to the constant warning to not fall through the absurdly wide crack between the subway and the platform. So, as the English like to say, as you make your Social Security timing decision, be sure to “Mind the Gap!”

Social Security and Whac-a-Mole

January 21, 2020 by Jason P. Tank, CFA

Whac-a-Mole was a truly frustrating game. Right when you smack your hammer on that mole’s head, another one pops up. It was so frustrating its name has now taken on the linguistic heights of Kleenex. Everyone knows exactly what you mean when you say it and they know how you’re feeling!

Navigating the world of Social Security is kind of like playing Whac-a-Mole. Just when you think you’ve got all the facts down, there’s yet another thing to clobber. Understanding how Social Security is taxed is particularly hairy.

Before jumping into an example, let me first state that about 45% of all retirees start to collect Social Security at the very earliest possible age of 62. Despite the massive financial incentive to file later, almost half of all retirees choose to take the money and run. What people might not fully appreciate is that for every $1.00 you’d receive at age 62, you could get about $1.75 if you waited to collect at age 70. For many reasons, good and bad, less than 5% of all retirees wait until age 70. If possible, more should delay.

To help shore up Social Security’s finances, benefits became subject to tax back in 1984. For lower income people, Social Security benefits are not included in their taxable income. For many others, a maximum of 85% of their benefit is taxed. About half of all retirees are paying some tax on their benefits. The true tax rate they pay can be surprisingly high.

For example, let’s imagine a married couple with $25,000 in pension income, $15,000 in interest income and $30,000 in Social Security benefits. Under a somewhat complex formula, this couple would see that about 50% of their Social Security is included in their taxable income. If they were to take $12,000 out of their IRA to help pay for a new car, the maximum 85% of their Social Security benefit would then be counted as taxable income.

Just like that frustrating game of Whac-a-Mole, the $12,000 IRA distribution for their new car resulted in about $10,000 more of their Social Security popping up on their tax return. It is very understandable for this couple to believe they’d pay tax in the 12% federal tax bracket on their IRA distribution. For them and the majority of other Social Security beneficiaries, however, the 12% tax bracket is a mirage. Without some tax planning, this couple really pays tax at a much higher marginal rate of 22.2%. I’ll say it again, Whac-a-Mole is really no fun!

To learn a bit more about the world of Social Security, attend the next Money Series on Wednesday, February 12 at 6:30pm in the McGuire Room at Traverse Area District Library. The Money Series is a Traverse City-based nonprofit committed to providing open access to financial education, for all. Register at MoneySeries.org or call (231) 668-6894.

Jason P. Tank, CFA is both the owner of Front Street Wealth Management, a purely fee-only advisory firm and the founder of the Money Series.

A New Year and a New Law for Your Money

January 3, 2020 by Jason P. Tank, CFA

Q: I turned 70.5 last year and my wife is going to turn 70.5 this year. I heard that the SECURE Act was signed into law right before the start of 2020. Do we both still have to take our required minimum distributions (RMDs) from our IRAs in 2020?

Just when you thought you understood the magical age of 70.5, you can now add the magical age of 72 to your repertoire! For people born before July 1, 1949, you will still live under the old RMD rule of age 70.5. For everyone else, your first RMD isn’t required until you reach age 72.

So, in your case, while you will still need to take out your RMD in 2020, your wife won’t have to take her first RMD until she turns age 72. Depending on her actual birthday and your tax situation, she might take her first RMD in 2021, 2022, or possibly even 2023.

As a little background, last summer, the House passed the SECURE Act with a nearly unanimous vote of 417-3 and sent it over to the Senate. For over six months, the Senate just sat on the bill. Some began to wonder if it might never become law. At the last minute, the SECURE act was sneakily tacked onto a routine year-end spending bill and signed into law on December 20.

The SECURE Act features a few other things to keep straight. It used to be that people had to stop contributing to their IRA once they reached age 70.5. That silly rule is now gone. And, you can still make charitable donations from your IRA once you reach age 70.5, even if you don’t actually have an RMD to take until age 72.

Q: I recently discovered a major problem with my taxes. My brokerage firm sent me a tax form that completely ignored the charitable donations I made from my IRA. I actually paid taxes on those donations. What are brokerage firms required to report to the IRS when it comes to the donations I make directly from my IRA?

Your question is literally a public service announcement. You are correct, brokerage firms report to the IRS all of the money you’ve taken out of your IRA. And, when I say all, I mean all! Nothing on your Form 1099-R (usually sent in early February) will indicate that you gave some of that money to charity.

As you found out, be sure to tell your tax preparer that you donated some of your IRA distributions directly to qualified charities. The donation you made then should be subtracted from the figures shown on your Form 1099-R.

For interested readers, you might want to review your old tax returns to make sure you got this right. If you find that you’ve made a mistake, remember you still have until April 2020 to amend your 2016, 2017 and 2018 tax returns!

Jason P. Tank, CFA is both the owner of Front Street Wealth Management, a purely fee-only advisory firm and the founder of the Money Series, a non-profit program committed to providing open-access to financial education, for all. Contact him at (231) 947-3775, by email at Jason@FrontStreet.com and at www.FrontStreet.com

Reflections on 2019, Onward into 2020

December 20, 2019 by Jason P. Tank, CFA

What a difference a year makes! At Christmastime a year ago, financial markets were in steep decline and fear was all around. The Fed had stubbornly been raising interest rates and the foreboding inversion of the yield curve was the topic of the day. Yet, after just one quick trip around the sun, financial markets in 2019 turned out to be simply marvelous.

If things stay steady for the final week, the stock market will be up about 25% to 30% for the year. This more than makes up for last year’s moderately negative year. The results rival the fantastic returns of 2017 and 2013; the best years of this current bull market. And, this year even stands toe-to-toe with the recession-recovery years of 2009 and 2003. It was a surprisingly good year.

As we all know, it’s not like things have been all peaches and cream lately. In the face of a slowing economy, the Federal Reserve suddenly reversed course and cut interest rates. The trade war with China was being waged basically all year long. Our largest companies delivered almost zero earnings growth. And, finally, we ended the year with an impeachment vote. With all of this, I don’t think many investors would have predicted such a strong market.

What made 2019 more marvelous was the big return in bonds. For the year, bonds delivered about 6% to 12%. Ironically, the driver that led to the great year in stocks was the same factor that drove up bonds; the Fed’s interest rate cuts in response to the fear of a possible recession. It’s not very often that worry of a recession produces both a rip-roaring move in stocks and bonds. But, it happened!

Politics aside, my current take on the state of the economy is it’s holding its own. The dangerous trade war has now morphed into a trade truce. And, the Fed has signaled that it is standing at the ready on the sidelines as it watches how things will unfold. Perhaps most importantly, the past concerns of an impending recession have all but disappeared.

You might be wondering, how did an investment adviser, like me, manage through a year like 2019 and what’s the game plan for 2020? As markets rose considerably throughout the year, I took two steps to lighten up on stocks and lower overall risk. My latest risk adjustment was done in August. The result is a larger-than-normal current allocation to short-term, safer investments. However, this type of conservative positioning can never be viewed as an endpoint.

After 20 years in the investment business, I’ve come to recognize that the tool that’s needed most to be successful is not a crystal ball. Rather, I rely most on an old-fashioned scale; working to weigh current risk against future reward. With many of the past clouds seemingly parting, I have some work to do in 2020. And, for that, I am thankful.

25 Days on Your Money Advent Calendar

December 6, 2019 by Jason P. Tank, CFA

As soon as the pile of Thanksgiving dishes had been cleared, we now find ourselves in the fast lane towards New Year’s Eve. To make this mad dash to the end of the year just a little more exciting, let’s pretend we all have a financial planning version of an Advent calendar with only 25 days left to open.

Let’s get started by highlighting a couple of pitfalls to avoid and some tips to consider.

Retired readers recently received their annual letter from Social Security. For the lucky few, some are slated to pay extra monthly premiums for their Medicare Part B and Part D benefits in 2020. This premium surcharge was triggered by making too much money way back in 2018; two tax years ago! The tax planning maneuvers you make in the next 23 days may save you a little financial heartache in 2021.

Medicare’s premium surcharges kick in at different modified adjusted gross income levels. The first surcharge adds about $800 per year more to your Medicare premium and is tripped at income levels of $87,000 for singles and $174,000 for couples. The second surcharge adds yet another $1,200 more per year and is triggered at income levels not much higher; $109,000 for singles and $218,000 for couples.

Avoiding or lowering the impact of these surcharges can take just a little bit of planning. Two common techniques are to deliberately harvest capital losses to offset any capital gains you have or to make charitable donations directly from your IRA to help reduce your required minimum distributions.

Now, moving on from the enviable challenges faced by higher income retirees, this next bit of planning advice is for those who qualify to receive health insurance premium subsidies under the Affordable Care Act.

The basic idea of Obamacare is simple enough. The law first aims to determine the premium level you can afford based on your income. In a nutshell, the law says you shouldn’t be expected to devote more than about 10% of your income to buy a decent health insurance policy. Naturally, the lower your income, the less the government expects you to devote to your health insurance coverage.

After you make your best guess about your income for the year ahead and you are told what you can afford toward the cost of a decent health plan, the government will provide you with an allowance to make up the difference between what can pay and what it actually costs. Once that allowance is set, you can then shop for the plan that’s best for you. You might even choose a plan that’s not quite as decent, such as a lower premium, high-deductible plan. The government allowance might even cover a significant portion of your monthly premium.

But, it’s very important to think of this monthly allowance as a government loan. If your best guess about your income turns out to be spot on, the loan is completely forgiven. If your best guess is too low, the government will want that loan paid back!

However, the Affordable Care Act is downright ruthless to those who make even $1 more than the qualifying income limit set at four times the poverty line. As soon as you cross that income threshold – again, even by $1 – the government says you could have afforded the full cost of your health insurance coverage and they’ll bill you at tax time for the entire loan they gave you.

To avoid this painful surprise, throughout the year you should closely monitor your projected income against the guess you made before the start of the year. If you think you will be close to the edge of becoming completely disqualified and if you did choose a lower premium, high-deductible plan, strongly consider making a contribution to a health savings account to get back below the income threshold. That one small maneuver alone might just save you thousands of dollars.