The federal government has passed a new tax law that will take effect in 2018. One of the changes is that they are limiting deductions for state and local taxes to $10,000.
What does this mean? This means that when you go to pay your taxes for 2018 (filed by April 15th, 2019), you will only be able to deduct $10,000 of your state and local taxes on your Federal tax return. For example, if you paid $13,000 in state taxes and $7,000 in property taxes in 2018, you will only be able to deduct $10,000. So, while in past years you would have been able to deduct the full $20,000, you will be limited to $10,000 in 2018. If your marginal tax rate is 28% (for example purposes), then the net effect will be $2,800 in more tax owed to the Federal government for this particular line item on your 2018 federal tax return.
But the impact of the new tax bill on your total taxes goes beyond just the state and local tax deduction limit. There are other changes to the tax law that will impact your net taxes. For instance, if you are in the 28% tax bracket in 2017, you will likely be in the 24% tax bracket in 2018, saving you 4% of your taxable income. So, you should look at all the changes to the tax law to determine what the net effect on your taxes will be. Here is a website that will allow you to enter your numbers to get a preliminary look: http://www.foxbusiness.com/politics/2017/12/19/tax-calculator-what-tax-reform-means-for.html.
As a result of the change to the state and local tax deduction, people are rushing to prepay their 2018 state and local taxes. The reason is that there is no limit to the deduction in 2017, so if you pay it in 2017, you can deduct it on your 2017 taxes. Local governments are reacting to this rush in different ways. Read more about whether your local jurisdiction is allowing prepayment in this article: https://wtop.com/local/2017/12/jurisdiction-accept-prepayment-real-estate-tax-new-law-kicks/
But should you prepay your taxes if they allow it?
First and foremost, you should consider your specific tax situation to answer this question. But if it turns out that you will benefit from prepayment and your local jurisdiction allows it, you’ll have to come up with that payment quickly – by the end of the week!
From a financial planning perspective, it makes sense to think about saving a potential $2,800 (given the example above). But with this example, you’d have to pay $10,000 by the end of the year. The first question is: Do you have that amount of money laying around? The section question is: Are you willing to forego access to that $10,000 in return for $2,800. The business case is sound, but does it fit into your budget?
With this example, you would pay the $10,000 right now, then have to update your withholdings for state taxes to increase your paycheck by $833.33 per month, slowly getting paid back your $10,000 over the course of the year.
Plugging this scenario into a calculator:
- Cash flow 0: -10,000 <– your initial payment
- Cash flow 1: 10,000+2,800 = 12,800 <– you get your $10k back over the course of the year, plus $2,800 in federal tax refund (that you wouldn’t otherwise receive next year)
- IRR: 28% <– this is the 1-year return for your $10k prepayment
If you are using your emergency fund to pay for this, you are increasing your risk in the case where you would need those emergency funds in 2018. Otherwise, why would you have $10k lying around? Perhaps you got an end of the year bonus or other windfall – these are probably the folks that are really considering this option. But others may be thinking about cashing in investments to prepay their state and local taxes. This comes with a whole set of other considerations – what the investment is for, the investment horizon, short term and long term capital gains taxes, taxes and penalties on qualified accounts, timing, transaction fees, etc.
But your scenario may be different. Your dollar amount might not be $10,000, your tax rate may be different, and your tax benefit may be different, so please run your specific numbers through a cash flow analysis.
– These are just a few items to consider among several.
I encourage you to run the numbers to determine if prepayment is right for you, or call your financial advisor.
Greg Caramanica, CFP®
My family and I just got back from an amazing week long trip to Europe and it didn’t cost us a fortune! But how? Surely, travelling to German Christmas markets (see picture above) in the height of the Christmas season would not be cheap – or so we thought.
A great strategy (that I share with many of my clients) for managing family finances is to have a primary credit card that both husband and wife use to charge most of their everyday expenses. This creates a centralized view of spending that makes it easier to identify when you are spending more than your budget allows and apply the brakes when needed.
This is not to say that you won’t have other credit cards. You will likely need a backup that you can use in case your main credit card gets stolen or is otherwise not usable. It’s smart to use this backup credit card for monthly subscriptions and other recurring fees that you don’t want to be disrupted if your main card stops working (which may happen more frequently if you are using it for everything else).
If you are using a main credit card for the majority of your everyday family spending, it is best to pay it off monthly or else you’ll start to accrue finance charges that will negate the benefits of this approach. You’ll also need to increase your emergency savings to cover a whole month of typical credit card spending, so that you can still pay your credit card balance from the previous month if you lose your job (or other disruption in income).
Using credit cards for everyday spending is not for everyone. If you have a tendency to overspend when using them, there are other techniques and approaches that may suit you better. Talk to your financial advisor to determine the right technique for you.
But if it works for you, consider the potential travel benefits! If you choose a credit card that has a travel rewards program (preferably with a low or no annual fee), you could build up benefits each year when using the card for the majority of your everyday expenses, which can add up quickly!
In our case, we were able to pay for four seats, round trip, from Washington D.C. to Munich, as well as a full week’s rental car with our travel rewards. This shaved over a thousand dollars off the cost of our trip, leaving us with expenses related to food, beverage (gluhwein!), lodging, and souvenirs. Lodging for most of the trip through AirBnB helped to trim that cost down even further – as well as a favorable exchange rate. In the end, we probably spent less than $2,000 for a week in Germany. And we had a great time doing it!
We also travelled to Austria to see the amazing Alps, pictured here:
If you’d like to talk more about this strategy and other strategies for affording the things you want in life, give us a call!
Danke (German for “Thanks”),
The end of year holidays are a joyous time that provide happiness to a great number of people. It is a time when we think of others and a time when the emphasis is on giving.
How do you survive the holidays, financially?
You might not like it, but the best way to control your spending is to create a plan and stick to it. This can be difficult for some, especially in the midst of the holiday season when the air is filled with excitement and the marketing machine of tv, radio, and print advertising perpetually encourage you to spend more. The idea of constraining your spending during the holidays can stir up many emotions, leaving you with mixed feelings.
Even though planning your holiday spending can be uncomfortable, we can all agree that our loved ones and friends would certainly not want us to go into debt. If they found out that we spent months recovering our bank accounts after the holidays, I’m sure they would rather have something smaller or less expensive instead. Could you imagine the guilt they would have if they found out they were the cause of your financial distress?
The balance of affordability and generosity is important. The holidays are certainly a time to give and feel good about bringing happiness to others. A proper financial plan can give you a feeling of freedom, knowing that you are spending in a responsible way and purposefully carving out time and resources for others without getting yourself into debt. It’s the no-guilt holiday approach. Doesn’t that sound amazing?
When should you create your plan? Well, the best time is in the beginning of the year, in January to April. This is the time when all your final numbers should be available about your prior year’s earnings, taxes, and spending when the buzz of the Holidays is no longer a factor. Creating a plan outside of the holiday season will reduce the negative emotions. Then, next year, you can look back on that plan and take your own advice, from a less emotional you, about how much to spend.
So, what can I do now?
Well, you can certainly take the time to prepare a rigorous plan during the holidays, but it’s better to wait. In the meantime, create a preliminary plan just focusing on holiday spending. You can do this by quickly looking back at last year’s spending and vowing to spend less. This is especially important for those of us who spent months paying off credit cards or dipped into savings a little too much, sacrificing other financial goals we had been saving for.
If you review last year’s spending and didn’t feel like you needed to cut back, then congratulations, you are one of the few that fit into this category. Just make sure you are being honest with yourself!
In summary, a sound approach for surviving the holidays, financially is:
- Take a quick look at last year’s spending and vow to spend less this year.
- Create a quick budget from these numbers, understanding how much you can spend on each person.
- Shop online if you can, so that you aren’t subjected to the messaging and spending environment as much as you would be if you went to the stores.
- Stick to your plan when buying gifts this year!
Then, in the first quarter of next year:
- Take stock of your earnings and spending for the previous year.
- Build a robust financial plan where you are honest with yourself about your financial goals and how you plan to accomplish them, taking everything into account and prioritizing. As part of this, create a budget for the year, including next year’s holiday spending with a clear mind, free of the holiday “buzz”
- And then, stick to your plan!
Happy Holidays everyone! Be safe!
Arlington Wealth Planning is a Registered Investment Advisor (RIA) and I am an Investment Advisor Representative (IAR). Many people may be wondering what that means and why it matters. Well, it’s a long story, but I will shed some light on the meaning here.
My understanding is that there are two main ways one can register themselves as a financial planner. He or she can either be a Registered Representative (RR) or an Investment Advisor Representative (IAR). Here are the big differences:
- Work for a “Broker/Dealer” that is a FINRA member firm. The Broker/Dealer provides compliance and access to the investment marketplace.
- Are required to pass FINRA exams, such as the Series 7 (General Securities Representative) and the Series 63 (Uniform State Securities Law), and maintain them through continuing education and further examination
- Are usually paid through commissions. For example, Registered Representatives would only get paid if you invest through them and typically they would receive commissions from the investment company.
- Typically are held to a standard of “suitability,” which means that they must provide investment advise that is suitable to the client’s needs
Investment Advisor Representatives
- Work for a Registered Investment Advisor (RIA) that provides compliance and access to the investment marketplace. In our case, Arlington Wealth Planning is the RIA and I am the IAR.
- Are required to pass FINRA exams, such as the Series 65 (Uniform Investment Advisor Law), and maintain them through continuing education and, possibly, further examination
- Are usually paid through fees. For example, the customer would pay the advisor for services provided, at a pre-agreed upon price. This payment is usually paid directly to the RIA and is not commission related (e.g. not paid as a result of selling an investment, but rather as a result of providing a service).
- Are typically held to a standard as a “fiduciary,” which means that they must have the client’s best interest mind, given their entire financial situation, when making recommendations.
Those two definitions may sound similar, but the last two bullets are significant – how we get paid and the standard to which we are held. There is a trend in the financial planning industry toward fee-based compensation (the RIA/IAR model). For instance, recently, the Department of Labor (DOL) published it’s Fiduciary Rule (currently on hold), which attempts to prevent retirement investments from being provided through the commission model (without a special contract). The justification is that there is a perceived conflict of interest for financial planners who earn a commission on the sale of investments, in that they may be drawn to recommend investment products that pay them more commission. While suitable, the product might not be the “best” product for the customer when you consider the rest of their financial picture.
This is where the standard is important. The suitability standard simply means that the investment recommendation must fit the client’s need. For instance, the client could ask the financial planner to invest $10,000 into a mutual fund. The planner’s job, under the suitability standard is to find the mutual fund that best suits the client’s investment horizon, risk tolerance, objective, etc. However, the fiduciary standard is different. Under the fiduciary standard, the planner would collect information about the client’s entire financial situation to determine whether a mutual fund is what should be recommended in the first place.
This example is fairly simple, but the situation can become quite complex. In our experience, the general sentiment of the people we serve is that they would rather pay a fee than a commission for financial planning. We at AWP agree. The fee-based business model makes more sense to us, as fees correspond to services rendered, and not to products sold. Tying compensation to services means that there is more of an incentive for planners to provide quality service, not just to push more product. We hope this means that customer service in the financial industry will be more important – like it is for us.
With the advent of information technology and the increased ability for people to find information at their fingertips, those in the financial planning industry might have been concerned that financial planners would go out of business. On the contrary, financial planners are being sought even more so – at least in our experience. What we’ve seen is that the availability of information has created consumers who are more financially literate and, as a result, are more aware of the kinds of things they should be concerned with. This awareness has nearly eliminated the need for financial planners to instill a sense of importance and urgency – clients already know that it is important to manage their finances and have a plan. Has this put financial planners out of business? In a word, no. The reason is simple. The prevalence of information, while making people more aware, has also resulted in an inundated consumer. The information that is so abundant is not just for financial planning, but for home renovation, car repair, economics, and any number of the million, or so, topics out there that one might be interested in learning. This torrent of information has created a more aware consumer, but also a consumer who is interested in finding a specialist who can help them to make sense of all the information. The availability of information has certainly changed the financial planning industry, but not how we thought. Instead of encountering people who are already experts in financial planning, financial planners are finding customers who are broadly educated in a number of areas and already understand the urgency of saving for their future, but looking for a partner to help them with the analysis and walk the path together. This is what we provide at Arlington Wealth Planning.