February 2020 Newsletter

If you let a $10,000 deposit sit in a standard savings account for a year, you’d earn a mere dollar in interest. That’s because most major banks out there offer an interest rate of 0.01 percent. But if you put that $10,000 in a high-interest savings account at an internet bank which offer interest rates between 1 percent and 1.55 percent or more (as high as 1.75 percent as of 2/1/2020), your $10,000 deposit could yield up to $155 (or more) after one year.

The reason internet banks can offer more interest is because they don’t have to spend money building thousands of branches and hiring people to fill them. The major drawback is convenience: It will take you a couple of days to access your money, whereas you get instant access, and lots of ATMs, with big banks.

You can earn even more if you use a certificate of deposit (CD), a savings account that offers a higher interest rate and fixed date of withdrawal. Again, you’re trading convenience for interest. With a CD, you agree to let your money sit tight for a set number of months or years, and if you withdraw your money early, you’ll be charged a penalty. If you can be patient, though, you’ll be rewarded with returns of about 2 percent or more.

Personal finance site NerdWallet did some number crunching to give you an idea of just how much money you may be leaving on the table if you’re not taking advantage of these options.

“Consumers lose out on hundreds or even thousands of dollars by keeping their money in low-earning accounts instead of high-yield savings accounts or CDs,” says NerdWallet banking expert Kimberly Palmer. “By earning more money on their savings, savers can stretch their money, and their budgets, further.”

NerdWallet’s charts below show how $1,000, $10,000 and $15,000 in savings would grow over time in four different places: under the mattress, a low-yield savings account, a high-yield savings account and a CD. It assumed a low-yield interest rate of 0.01 percent, a high-yield interest rate of 1.55 percent and CD interest rates of 1.75 percent for one year, 2.05 percent for three years and 2.45 percent for five to 10 years.

Experts advise that you look at these different vehicles as a better way to earn money on your emergency fund or short-term savings goals, rather than as your entire investment strategy. For long-term investments, you may want aim for higher returns by investing in retirement savings accounts like a 401(k) or IRA and considering low-cost index funds, which Warren Buffett recommends, and ETFs.

But if you want to earn more on the money that’s just sitting in your savings account, check out NerdWallet’s savings rate tool to find the highest savings rates available to you and CD rate tool to find the highest CD rates.

^{Source: Elkins, K. (March 16, 2018). https://www.cnbc.com/2018/03/16/why-you-should-use-a-high-yield-savings-account.html}

Most tax filers look for every opportunity to reduce what they owe the IRS. And one of the biggest ways to reduce your tax bill is to be smart about the deductions you claim.

You’ll have the choice between two options when you decide how to structure your deductions: You can itemize, or you can claim the standard deduction.

You don’t want to make the wrong choice and be taxed on more income than you should, so you need to know how much the standard deduction is worth. While the amount depends upon your filing status, there’s some good news for every tax filer — the standard deduction will be higher in 2020.

How much is the standard deduction going up?

The table below shows the increase in the standard deduction from 2019 to 2020 for each tax filing status.

How does claiming the standard deduction work?

If you claim the standard deduction, you’ll subtract this amount from your income to determine how much money you’re taxed on.

• If your income was $20,000 and you file as single, subtract $12,400 from $20,000. You’ll be taxed on just $7,600.
• If you file as married filing jointly and your combined taxable income was $50,000, subtract $24,800 from $50,000. Your taxable income comes down to $25,200.

When you claim the standard deduction, most other deductions are off limits. You can’t also take a deduction for charitable contributions, for example, or for property taxes or mortgage interest. If the deductions you have for specific expenditures exceed your standard deduction, you’d want to itemize instead of claiming the standard deduction.

There are a few deductions you can still claim along with the standard deduction though. You can still claim deductions for IRA contributions, for student loan interest, and for contributions to a health savings account.

So if you are married filing jointly, you made $3,000 in tax deductible contributions to an IRA, and you’re eligible to claim the full $2,500 deduction for student loan interest, you could deduct a total of $30,300 from your taxable income.

When you take a deduction, you simply reduce the amount of income you are taxed on. If you have $30,300 in deductions and your household income was $50,000, you’d only be taxed on $19,700 of that income.

Deductions are different from, and not as valuable as, tax credits which provide a dollar-for-dollar reduction in the tax owed. While a deduction lowers your tax bill because you don’t pay tax on the deducted income, a credit wipes out a portion of tax you’d otherwise owe. If you owe $5,000 in taxes and take a $2,000 credit, you’ll now only owe $3,000.

Millions of taxpayers will benefit from the higher standard deduction

The standard deduction is quite high so many taxpayers find it’s better to claim it than to itemize. All of these taxpayers will benefit from the increase in the standard deduction.

While these increases generally occur every year to keep pace with inflation, it’s still nice to know that you’ll be able to subtract a little more from your taxable income in 2020 than in the past.

^{Source: Bieber, C. (January 13, 2020). https://www.fool.com/taxes/2020/01/13/the-standard-deduction-will-be-a-little-bit-bigger.aspx}

Municipal bonds may seem like a perfect investment. Income that isn’t subject to taxes—what could possibly go wrong? Not much, especially if you stick to the higher-rated issues, but that doesn’t make munis right for everyone.

First, a quick recap: Municipal bonds are issued by cities, counties states, and other municipal authorities as a way of raising revenue for earmarked public projects. The interest rate paid by munis tends to be lower than that of corporate bonds. However, because the ventures they’re financing are considered to serve the greater good, the interest is free from federal income tax—and state and local taxes as well, if it’s issued in your locality.

When an investor buys a ​muni, he’s expressing a willingness to forgo a higher yield on his investment dollars in exchange for not having to pay taxes on the gain. That’s a pretty good move for high-income individuals, but buying a taxable bond that pays a higher interest rate usually makes more sense for the rest of the world. So where do you and your net worth stand on the should-I-or-shouldn’t-I muni scale? Answering a few key questions should help you figure that out, and ultimately decide if these instruments make sense for you.

What’s Your Federal Tax Bracket?

If you don’t know the answer, call your accountant. If you don’t have an accountant, get one. If you’re one of those do-it-yourself types who won’t get an accountant, take the time to research your tax bracket. You can’t assume that it stays the same from year to year if your income fluctuates.

What’s Your Reciprocal Bracket?

Subtract your tax bracket from 100 to get your reciprocal bracket. For example, if you’ve determined that you’re in the 32 percent bracket, then 100 less 32 is 68. So your reciprocal bracket is 68 percent.

What’s the Interest Rate on the Muni?

The top-rated 10-year tax-exempt bonds yield anywhere from 2.6 to 3.05 percent as of December 2018, but it can depend on the year or even on the week or the month. We’ll use the upper figure in this scenario.

What’s Your Tax-Equivalent Yield?

Here’s where you decide if a particular muni is for you. Divide its yield—let’s say, 3.05 percent—by your reciprocal rate of 68 percent and you’ll get 4.48 percent. That’s your tax-equivalent yield—your muni tipping point, so to speak. It means that, with everything else such as maturity and rating being equal, a taxable bond has to yield more than 4.48 percent to make more sense than the 3.05 percent tax-exempt bond for someone in your tax bracket.

Where Do You Live?

Earnings on all muni bonds are exempt from federal income taxes, but you’ll pay local taxes on muni earnings from bonds outside your state. If you buy one in the state in which you live, though, there’s a good chance that the interest from it won’t be subject to state and local taxes, either (these are known, respectively, as “double-exempt” and “triple-exempt” bonds). So if you reside in a high-tax state like California or New York, buying a local muni bond will add to your tax break. Calculate your state and local tax rate and your reciprocal rate, then duplicate the process that’s explained above.

You can also use a web-based calculator to run these numbers. After you’ve done so for a few candidates, you should eventually be able to tell at a glance whether a particular muni bond makes sense for you and your portfolio.

^{Source: Conley, P. (July 28, 2019). https://www.thebalance.com/buy-municipal-bonds-417157}