November 2019 Newsletter

Several significant tax and savings deadlines are fast approaching. Before you flip your calendar to December, consider making some of these smart money moves.

As you approach the end of the calendar year, there are many financial deadlines and cutoffs that you may not be aware of. From minimum distributions to annual gifting exemptions to tax-loss harvesting, there are more annual rules and limitations than any one human could reasonably be expected to know.

To simplify the year-end management of your finances, here are the top nine deadlines and cutoffs to be aware of.

Required minimum distributions: Dec. 31

For those over the age of 70½, RMDs are annual withdrawals required by the IRS to be made from qualified retirement accounts. These include standard IRAs, 403(b)s and 401(k)s if you no longer work at the company, but exclude Roth IRAs, which are funded with post-tax deposits. The RMD for each account is determined by the IRS based on the balance of the account as of Dec. 31 of the prior year and your age, among other factors. If you have an adviser or family office who assists you with your financial planning, you can task them with ensuring that your RMDs are made, but if you manage your accounts yourself, this is a withdrawal you must remember to execute every year prior to Dec. 31. If you fail to do so, the difference between the RMD for each account and the amount you withdraw will be hit with a whopping 50% penalty. (To figure out your own RMD, see Calculate Your Required Minimum Distribution From IRAs.)

Capital Gains distributions: Vary by fund, but generally in November and December

Mutual funds are mandated by law to distribute at least 98% of their net capital gains (after “netting” out trades with losses and gains) to shareholders once per year, typically in November or December. These distributions are significant – in 2018 an estimated $300 billion was paid out, according to the Investment Company Institute. ETFs are also required to pay out capital gains distributions annually, although for ETFs this is more infrequent. If your funds are owned in a qualified retirement account (meaning one that grows tax-deferred, such as a 401(k) or IRA), there will be no capital gains liability. But if they’re owned within a taxable account (like a trust or an individually held investment account) the capital gains distribution must be accounted for when you prepare your tax return. It’s important to monitor your capital gains distributions because you will likely owe taxes on them, and they could even move you into a different tax bracket.

Max out employer-sponsored retirement plan contributions: Dec. 31

For all employer-sponsored retirement plans, there are annual contribution and salary deferral limits. These caps vary from account to account, and in some cases, depending on the age of the employee, but for many people planning for retirement, maximizing their contributions for the year is an important part of the plan. The deadline for your annual contributions is Dec. 31, but since these contributions are generally made as a percentage of your gross income withheld, to make any year-end adjustments, you’ll need to coordinate with your HR department and leave enough time for your change to be implemented and make an impact.

Tax loss harvesting: Dec. 31

Tax-loss harvesting is a strategy where an investor sells a position for a loss to generate a tax deduction and offset other investment income. Investments sold to implement this strategy fall into two tax categories: short-term and long-term. Any security held for less than 12 months is considered a short-term investment. Securities held for 12 months or more are considered long-term. Losses from the sale of either are applied first against gains in the same class — meaning long-term losses are applied against long-term gains, and short-term losses are applied against short-term gains. Up to $3,000 of leftover losses can be used to offset other gains, including ordinary income and taxable interest.

For example, if an investor has more long-term losses than long-term gains, the excess losses could be applied to short-term gains as well, and up to $3,000 of ordinary earned income if there are long-term losses in excess of both long-term and short-term gains. Lose more than that? Any remaining losses can be carried over to next year. But all tax loss harvesting must be applied to the matching class of gains first.

When using this strategy, it is also important to be cognizant of the wash-sale rule, which requires that you wait 30 days before repurchasing the same security for the sale to be recognized as a sale and for the loss to apply.

Roth IRA conversions: Conversion deadline Dec. 31, contribution deadline April 15

There are a number of reasons why you may wish to convert a traditional IRA into a Roth IRA. The retirement advantage is that when you withdraw funds in the future, they will be tax-free (as long as you’re 59½ and have held the account for five years) and there will be no RMDs. The lack of RMDs allows you to determine how much of the money will remain in the account and continue to grow tax-free. In addition, should you wish to leave your Roth IRA to a beneficiary as part of your estate, they will not be assessed income tax on their distributions either.

All contributions to the traditional IRA for which you received an income tax deduction and all associated growth will be taxed as ordinary income in the year you convert to a Roth IRA. The conversion must be completed by Dec. 31, but if you’re just contributing to an existing Roth IRA, you have until April 15, 2020, to have that contribution count for the previous year (2019).

Charitable donations: Mid-December

Although the deduction structure changed with the implementation of the Tax Cuts and Jobs Act, if you itemize, you can still reduce your taxable income through charitable contributions. But you should keep in mind that it takes the charitable organization time to process the donation. So don’t wait until the last minute, especially if you’re contributing appreciated securities, which take longer to process than cash. For many institutions, the cutoff for the current year’s contribution of appreciated securities is around mid-December.

Max out your HSA: April 15

A health savings account can be used to pay for medical expenses, reduce taxable income and can play a key role in retirement planning. It is also the only account with a triple tax benefit: Tax deduction, tax-deferred growth and tax-free withdrawals if used for qualified health expenses. The maximum annual contributions are $3,500 for individuals or $7,000 for a family. If you are 55 or older you are allowed to make an additional catch-up contribution of $1,000 to your account. Similar to IRAs, the cut-off date for annual contributions is April 15.

Spend unused FSA money: Generally, June 30 or Jan. 31 – determined by your health care plan

Many health care plans include a flexible spending account that you can contribute to with pre-tax dollars. FSA money can be spent on co-pays, lab work, glasses or any other qualified medical expense. The catch is that only $500 can be rolled over to the next year, and any unused funds beyond that amount will be lost. Check with your health insurance provider to verify the cutoff dates — most plan years end either on Jan. 31 or June 30. If you anticipate a remaining balance in your FSA greater than $500 at the end of your plan year, visit www.fsastore.com where there is surprisingly wide range of approved FSA items you could purchase.

529 contributions: Dec. 31

Donations to a child, relative or friend’s 529 account count as a gift for tax purposes, and they are currently limited to $15,000 a year, per person, to avoid paying a gift tax or having the gift count against your lifetime gift exemption. If you want to maximize the amount you are giving to a 529 each year, the cutoff is Dec. 31.

^{Source: Casey Robinson, CFP®, Waldron Private Wealth, November 14, 2019}

2019 U.S. home prices are falling as the market absorbs the 2017 Tax Act changes. Meanwhile, other factors are hampering the housing market and point to a potential recession ahead.

By this year end, U.S. home prices are likely to be 4% lower than what they could have been without the tax changes that took effect in 2018, according to Moody’s Analytics chief economist Mark Zandi. The 2017 Tax Cuts and Jobs Act placed a cap of $10,000 on federal deductions for state and local real estate and income taxes, and eliminated some mortgage interest deductions.

Those two tax changes and higher mortgage interest rates caused by higher federal budget deficits are responsible for lower home valuations, Zandi recently told ProPublica. The report calculated the “setback” in U.S. home values at $1.04 trillion on a base of $26.1 trillion, which was the total value of U.S. homes as of March 31, 2019.

Other factors that make it worse for the housing markets are slowing sales, slowing new construction and rising prices, especially for affordable homes. All of those could signal the next recession, according to Zandi and Susan M. Wachter, Wharton professor of real estate and finance. They discussed those trends and the outlook for the U.S. housing markets during a recent podcast with Knowledge@Wharton.

Blow by blow

The growth in house prices nationwide has fallen to about 3% from levels of 6%–7% before the tax bill’s provisions took effect, said Zandi. The impacts will be most significant in places where home prices and real estate taxes have been high, such as the Northeast Corridor, particularly around New York, the Philadelphia area, Washington, D.C., the Chicago area and California, he said. In fact, house price growth has slowed the most in those areas compared to the rest of the country where the effects of the tax law would be less significant, he added.

However, his estimates on what home prices would have been without the tax changes are based on assumptions that other factors stay constant. “We don’t know what the counterfactual is,” he said. “We don’t know what the world would have been without the tax cut [bill].” According to latest data, prices for luxury homes are down 1.6%, while those for non-luxury homes ($300,000 or under) are up about 2.6%, said Wachter, who is also co-director of the Penn Institute for Urban Research.

Of the estimated home-price damage to about 3,000 counties throughout the country, the biggest estimated value loss was in Essex County, N.J. (11.3%), followed by Westchester County, N.Y., suburban New York City (11.1%); and Union County, N.J. (11%), according to the ProPublica report. Zandi’s county-by-county list can be found in ProPublica’s Data Store.

Hugh Lamle, former president of M.D. Sass, a Wall Street investment management company, explained the math behind those estimated losses in valuation in the ProPublica report. Home buyers would have typically figured out how much house they can afford by calculating how much they can spend on a down payment and monthly mortgage payment, adjusting the latter by the amount they’d save via the tax deduction for mortgage interest and real estate taxes, the report said. Lamle’s model figures out how much prices would have to drop for the same monthly payment to cover a given house now that this notional buyer can’t take advantage of the real estate tax deduction and might not be able to take full advantage of the mortgage interest deduction.

According to Zandi, “the most direct impact is through the scaling back of the deductions in the tax code that are intended to promote owning a home.” That, along with the lower mortgage interest deduction, made it relatively less attractive for many people to buy homes, thereby hurting overall demand for housing.

Prior to the Tax Cuts and Jobs Act, homeowners could deduct interest on up to $1 million of home acquisition debt or $500,000 for those with the tax status of “married filing separate,” a MarketWatch report explained. The tax bill lowered those eligible deductions to up to $750,000 of mortgage debt for individuals, and to $375,000 for those using the “married filing separate” status.

“When demand for housing weakens, that comes at a price,” said Zandi. The casualties were not just on home values, but “on the economy, jobs, interest rates, and everything else,” he added.

Wachter noted that “home ownership is declining a bit after it increased slightly.” She broke it down to specifics, and pointed to “continued pressure on prices” in the non-luxury segment, particularly the starter home bracket. Also, “millennials are still not buying,” she said. “First-time home buyers now make up less than one-third—an all-time low, and down from more than half in earlier years. Even as mortgage rates are at historic lows, prices for affordable homes continue to rise faster than overall prices, and faster than wages and incomes, except for those at the top end of the market,” she added.

Affordability concerns

“So, affordability is not easing up where it matters,” said Wachter. “This is a concern obviously for home ownership in the future. For the economy and for affordability it is a concern, [as it is] for families to get on that ladder of home ownership so that they can save and protect themselves against future rent rises, because rents are rising even faster.” Also looming on the horizon are fears of when the next recession might arrive. “Housing is clearly a bellwether for that,” she said. “If sales are slowing, that’s one more factor that may push us over to a recession.”

Zandi noted that during most of the economic expansion since the last recession a decade ago, the large, publicly traded builders had focused on the high end of the market, both in single-family homes and the apartment markets. However, as market conditions changed because of the tax law, they have had to switch gears and are now focused on the more affordable parts of the market, he said.

Builders have hitherto largely ignored the affordable rental market, but are now attracted to that segment, where rents and prices have risen on the back of severe shortages, he added. He noted that the market needs new construction of both affordable single-family homes and affordable rental units.

Even as builders are stepping up their activity in affordable segments, most of the demand for such housing is in urban areas, where they face difficulties in building because of stringent zoning and permitting issues, Zandi noted. “It’s a catch-22 situation because rents are rising where the job market is—that’s exactly where people want to go to,” said Wachter. But high rents mean that aspiring first-time homeowners cannot save enough to meet their down payments, which further fuels demand for rental housing, and rent increases, in a cascading effect, she explained. “Historically, we haven’t seen rents increase so much for so long—and it’s likely to continue.”

Different strokes

Zandi explained why the tax code changes hurt home values more in some markets such as in New York, New Jersey, Chicago and California than in others. Homeowners in some of those communities pay comparatively more in property taxes than elsewhere. “It’s one of the key ways those local governments fund themselves and provide the government services that they do to their residents,” he said. “[The tax act] goes beyond just the direct effect in terms of the deductions for housing. It goes to the impact on the finances of those state and local governments, and to the location decisions of businesses.”

The tax act also had the effect of increasing the federal budget deficit to cross the $1 trillion mark and put it on an upward trajectory as a share of the GDP. That caused interest rates to rise, although they have since declined, but one unexpected setback came with the trade war, which did “a lot of damage,” said Zandi.

The regions that are taking a bigger hit than others are those that are export-intensive, said Wachter. “For the first time, we’re seeing population declines in large markets like the New York City Metro area, Washington, D.C., and Los Angeles, which are also hit by trade declines, especially in service industries,” she added. “We see movement toward the more affordable Southern and Midwest markets. We’ll have to wait and see whether this is a long-term trend. But it’s a pretty stunning development.”

“The tax law effects have knocked the wind out of the Bay Area housing market, which is the poster child,” said Zandi. “House prices over the last year or two since the tax law change have weakened considerably, and have been declining more recently.” Added Wachter: “Prices are coming down, and in New York City and San Francisco, for some, they are for the first time affordable.”

The recently lower interest rates have helped lift housing activity, and home sales and new construction are starting to improve, Zandi said. However, it isn’t entirely clear if those trends will make way for home prices to increase.

A slow adjustment

According to Zandi, the housing markets will absorb the impact of the tax changes, and settle into a new normal. The tax changes are “like a one-time hit; it will mean a one-time adjustment,” he said. “The market will adjust to the new tax law. It may have a bit more to go, but we’re pretty close to the end of the process. And then, all the other things that matter to housing demand and supply, and house prices, will kind of kick into gear and will move forward.”

Not everybody lost out with the tax changes. The cut in corporate taxes benefited investors, who saw their stock values rise as a result, Zandi noted. “The very wealthy who have large stock portfolios may say, ‘OK, I lost a little bit on my house, but I gained a lot from my stocks,’” he said. “But for middle-income Americans who don’t own a lot of stock, and their house is the key asset that they own, the tax law was a negative because they lost a lot more from the reduction in their housing value compared to what they gained in terms of rising stock values.”

^{Source: Knowledge@Wharton.com, Oct 29, 2019}

Many people have an all-or-nothing view of work. But there can be a downshifting phase before full retirement that brings both fulfillment and increased savings.

I have a friend who plays principal clarinet with a major symphony orchestra. She loves her work—which, after all, is literally playing—but at age 61 she’s getting tired of the grind. When I visited her recently, she started asking me retirement questions: How much will she need? How will she know when she’s ready? When should she take Social Security? And so on.

Now, my friend Leah (not her real name) loves the creative aspects of her work—interpreting the music, playing solos, teaching students. But other aspects of the job, like some of the obligatory community outreach activities, no longer hold her interest. When I suggested that she offload some of these activities to younger members of the orchestra, she said she thought that wouldn’t be fair to them, that as principal she should be a good leader and get down in the trenches with them. Yet because this part of the job was so wearing on her, she was thinking about retiring from the orchestra altogether.

Speaking on behalf of the thousands of concert-goers who love her playing—she is now one of the top clarinet players in the country—her absence from the orchestra would be a tragedy. She probably has at least 10 more years of world-class playing left in her, and honestly, she’s better now than she’s ever been. She hasn’t lost any of her technical proficiency, and her interpretive skills have improved with age. There must be a way for her to downshift into a situation where she can keep doing the things she loves and offload the things she doesn’t love. At this stage in her career, she deserves it.

As I’ve thought about this further, I’ve realized that many baby boomers’ eagerness to retire isn’t so much about the work, especially the more enjoyable aspects of the work, but about the daily grind. Setting the alarm clock five days a week. Commuting to the office. Attending meetings. Dealing with paperwork. Interacting with crabby co-workers and customers. What if retirement planning started with an exploration of how to make the job more enjoyable? This would allow baby boomers to stay a few more years on the job, enjoy what they’re doing, and help forestall the brain drain that will eventually remove from the workplace and the world at large all the knowledge and skills retiring boomers will be taking with them.

Aging scientist Ursula Staudinger is on a mission to maximize human resources that are dwindling around the globe due to declining birth rates. In Maximizing Our Aging Potential, she says that shortages in specific occupations are already becoming more prevalent in Western Europe and in some U.S. industries. She adds that older workers are valuable to employers because of some of their patterns and habits of work, such as loyalty, reliability, promptness, and strong interpersonal skills—not to mention that older workers often hold a business’ valuable networks and institutional knowledge. “In order to innovate and create sustainable societies, we need to understand whether and how we can maximize human potential in later life,” she says. How to do it? Keep work interesting.

That last stage before retirement

People who are tired of the daily grind may see full retirement as their only out. Yet they may have mixed feelings about stopping work completely. They like what they do, feel valued for the contribution they are making at work, and certainly appreciate the paycheck. If only they didn’t have to deal with commuting, meetings, paperwork, boring projects, or, in Leah’s case playing music she doesn’t enjoy, they would be more than willing to stay on the job a few more years. Whether it’s working fewer hours, shifting into a more advisory role, or remaking the job to include more exciting projects, most people probably have some idea of how they could make their current jobs better.

Consider a downshifting plan. Think about your work—what you like, what you don’t like, and what your perfect job would look like. Brainstorm ways your job could be more enjoyable. Ask yourself, “What would it take to keep you at your job a few more years?”

Some people might simply like to work less and would be happy with a shorter workday or a four-day work week. Others might like a stretch of time off, even if it means not getting paid for the extra vacation time. People tired of commuting might want to work from home one or two days a week. Those who hate meetings or paperwork might ask to be relieved from these activities. Some people might want to change the nature of their work by proposing exciting new projects that would keep them even more engaged.

I am used helping preretirees imagine their perfect retirement by thinking about where they would live and what they would do with their time. Before going there, I help them imagine the perfect job as a transition to retirement, say for the five or so years before they call it quits for good. We’re not talking about retiring and then finding a low-paying part-time job. Rather, we’re talking about working at the same high (or maybe slightly reduced) pay while downshifting in the same career in order to make use of that vast amount of experience and expertise the worker has accumulated.

How to downshift

Business owners and self-employed people have an easier time downshifting than employees because they are their own boss. In fact, these people are probably in no hurry to retire because they’ve already worked themselves into a situation that allows them to stay involved in the business, minus the headaches. They can choose their clients, choose their hours, offload mundane activities to employees (without feeling guilty about it), and only do projects that excite them. Downshifting comes naturally to business owners who, at some point, find themselves in the best of all possible worlds: less work, more enjoyable work, continued contribution to the world, and little or no decrease in earnings.

People who work for an employer may have a bit of a challenge as they seek to downshift into a less intense role at work. A 2017 GAO report, “Older Workers: Phased Retirement Programs, Although Uncommon, Provide Flexibility for Workers and Employers,” says that formal phased retirement programs are still relatively rare. Not only do employers see such programs as being expensive and difficult to administer, they worry about potential liability related to age discrimination. However, the report does cite benefits to employers who have instituted phased retirement programs, the main ones being the retention of knowledgeable, highly skilled workers, and the transfer of knowledge to younger workers.

Downshifting proposal

So I propose that instead of waiting for their employer to institute a company-wide phased retirement program, people approaching retirement age craft their own “downshifting proposal” that suggests ways the job can be altered to accommodate the needs of both the employer and the employee. An employer worried about brain drain wants to keep valuable workers on the job and retain the institutional knowledge they’ve accumulated. Employees who like their work want to stay involved while also having more balance and downtime in their life. Surely they can work out an arrangement to give them both what they want.

As with any proposal an employee might submit to an employer, start by emphasizing benefits to the employer. In exchange for more time off (or whatever the employee is asking for), the employee would promise to contribute his skills and experience for the betterment of the company and also help to transfer knowledge and skills to younger employees via training or mentorship projects. Many older workers are highly suited to teaching and mentoring; in fact, it’s surprising these programs aren’t more prevalent in the workplace as boomers get set to retire.

Submitting a downshifting proposal saves an employer from bringing up the touchy issue of age, and may also lead to a more workable plan for both of you. Indeed, it behooves the employee to submit a downshifting plan because the employer may not even know what it would take to keep the worker happy. Different hours? Different projects? Work from home a couple of days a week? A four-day work week? An employee who is familiar with both the employer’s needs and the role he or she has been fulfilling is in the best position to craft the downshifting proposal.

Downshifting to self-employment

In some cases downshifting may involve branching out from current employment to self-employment. A common example is where an employee “retires” and goes back to work for the same company as a consultant. But downshifting can take other forms too, such as freelancing for multiple clients or teaching. The cloud accounting company FreshBooks has been studying the next wave of self-employed professionals, defined as traditional employees considering self-employment within five years. Here is what’s driving them, according to FreshBooks 3rd Annual Self-Employment in America report.

22% Control—choosing where to work, choosing when to work, managing career development

22% Fulfillment—more day-to-day happiness, making a difference, being more challenged

20% Finances—earning more money immediately, earning more money at a later time, having more money for retirement

14% Family—spending more time with family, flexibility to care for young children, flexibility to care for aging dependents

12% Change—pursuing a different career, shaking things up, working with new people

6% Health—address declining physical health, prevent additional burnout, address declining mental health

4% Negative work environment—escaping office politics, feeling underappreciated, leaving behind a bad boss

Self-employment is a natural transition for older workers who may be better equipped than younger workers to overcome one of the key barriers to self-employment: financing. Older workers also have a head start due to their specialized skills, cultivated networks, and a well-developed work ethic. People age 65 and older can go onto Medicare and not worry about giving up employer-sponsored health insurance.

Benefits of working longer

For people questioning the idea of downshifting, claiming to be sick of work and wanting to retire completely, start by running the numbers. Can they really afford what might turn out to be a 30-year retirement? If so, great. Then they have lots of flexibility and should consider all of their options, including downshifting their work for the social benefits of continued participation, if nothing else.

For people whose retirements are marginally funded, look into how working just a few more years can make a big difference in their retirement security. The NBER paper “Working Longer Can Sharply Raise Retirement Income” says that a 66-year-old worker who works one year longer and claims Social Security one year later sees a 7.75% rise in his inflation-adjusted retirement income, 83% of which comes from the rise in Social Security benefits.

One advantage to take Social Security at 70 is that it resets the retirement target further out from 62, which is when people have typically started thinking about it. I saw this in my conversation with Leah. Even though she is going strong in her career, her 61st birthday triggered thoughts of retirement. Once we looked at her Social Security analysis and showed her how much more she would gain by claiming at 70, I could almost see the gears in her head shifting to a later retirement age.

People who make the decision to start Social Security at 70 figure they might as well keep working during their 60s rather than tapping their retirement savings. This ends up giving them more Social Security and a bigger base of retirement savings to draw from later. The NBER researchers observe that for a 62-year-old “working eight additional years will increase retirement income by at least 40% and above 100% for some individuals.”

In praise of older workers

The Center for Retirement Research at Boston College has taken a strong position advocating continued employment for older workers, mainly because longer life expectancies and insufficient savings require it. If any employer needs to be sold on the idea of retaining older workers, see “The Business Case for Older Workers,” which says in part:

Older workers today are healthier, better educated, and more computer savvy than in the past and, in terms of these basic characteristics, look very much like younger workers. In addition, they bring more to the job in terms of skills, experience, and professional contacts. Finally, they are more likely to remain with their employer longer, and longer tenure enhances productivity and increases profitability for the employer. All of these benefits more than offset any remaining cost differentials between older and younger workers.

As for retirement’s effect on health, the research is mixed. Retirement has a negative impact on cognitive ability, according to a RAND study. Retirement leads to a less stimulating daily environment and reduces the incentive to engage in mentally stimulating activities, such as those that would be required in the workplace. Older people who work do tend to be mentally and physically healthier, but it’s not clear whether working confers those benefits or people who have them are more likely to work. But there is good evidence that working past retirement keeps your brain sharp.

^{Source: Elaine Floyd, CFP®, Nov 7, 2019}