Topic: Taxes

Benjamin Franklin famously once said that “Money makes money. And the money that money makes, makes more money.” He was referring to compound interest. When interest you earn on a balance in a savings or investment account is reinvested, you earn even more money. You aren’t just earning interest on your principal balance; you are earning interest on your interest as well.

For example, if you make a one-time investment of $10,000, then earn 9% per year, the chart below shows the power of compounding your money. After 10 years. the initial $10,000 investment would be worth more than $24,000 — and after 30 years, it would be worth more than $133,000.

There is a shortcut to help you estimate the value of a future investment, called the Rule of 72. It’s a quick way to estimate approximately the number of years it will take to double your money using compound interest. As seen in the chart below, if you earn a 6% compounded return per year on your investment, then in about 12 years your money would be worth double. If you annualize 12% a year for 48 years, $10,000 could turn into over $2,500,000! To use the Rule of 72, simply divide 72 by the expected annual rate of return and that will provide you the number of years it would take to double your investment.

Simple interest is interest that is earned based solely on the principal amount and is not reinvested. For example, if you have $1,000 and earn a 5% annual interest rate, you will get $50 a year in simple interest. In the second year, you would earn another $50. To calculate how long it would take to double your money with simple interest, the formula would be 1 divided by the rate of return. For example, if you made the same investment of $1,000 earning 5% simple interest, it would take you 20 years to double your money. Note that if you were able to reinvest the money and have it compounding, then it would take approximately 14.4 years to double.

It is important to consider tax implications prior to making any investment. If an investment is going to pay 10% interest on your principal and is in a taxable account, your actual return may be only 6% if you are in a top tax bracket and the income is taxed as ordinary income. If you are not able to reinvest the income, then the income becomes simple interest, and your money can take even longer to double. Suddenly, the 10% investment return that sounded great may not be nearly as good.

• Capital gains are profits from the sale of an asset. If you own the asset for more than one year and you sell for a gain, then you will pay long-term capital gains tax. The rate depends on your income level and can either be 0%, 10% or 20%. If you own the asset less than a year and sell it for a gain, then the gain will be taxed as ordinary income.

• Dividends usually are taxable income in the year that they are received. Even if you reinvest the dividend income, you pay tax on that income that year. There are two types of dividend income – qualified and non-qualified. Non-qualified dividends are taxed as ordinary income. Qualified dividends are taxed at either 0%, 15% or 20%, based on income level. 

• Investments in 401Ks or IRAs allow you to defer taxes while the money is inside the account. Taxes are paid when you make a withdrawal, and that money is then considered ordinary income and is taxed at your income level.

Portfolio design and allocation are very important in order to minimize the tax impact on your returns. Structuring the portfolio to have the least tax-efficient assets in retirement accounts helps ensure that those assets are being taxed at ordinary income levels. The chart below shows the difference that tax management can have in a portfolio over time. If your portfolio is managed inefficiently — if it is heavily traded and focused on short-term gains — a $1 million portfolio could miss out on as much as $500,000 of returns over a 10-year period. Compound interest is an extremely powerful tool — whether it is in a retirement account, such as a 401K or IRA, or a taxable account, earning qualified dividends that are reinvested. 

The CD Wealth Formula

We help our clients reach and maintain financial stability by following a specific plan, catered to each client. 

Our focus remains on long-term investing with a strategic allocation while maintaining a tactical approach. Our decisions to make changes are calculated and well thought out, looking at where we see the economy is heading. We are not guessing or market timing. We are anticipating and moving to those areas of strength in the economy — and in the stock market. 

We will continue to focus on the fact that what really matters right now is time in the market, not out of the market. That means staying the course and continuing to invest, even when the markets dip, to take advantage of potential market upturns. We continue to adhere to the tried-and-true disciplines of diversification, periodic rebalancing and looking forward, while not making investment decisions based on where we have been.

It is important to focus on the long-term goal, not on one specific data point or indicator. Long-term fundamentals are what matter. In markets and moments like these, it is essential to stick to the financial plan. Investing is about following a disciplined process over time.

Sources: Fidelity, Forbes, Investopedia, Russell Investments

This material contains an assessment of the market and economic environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. Forward-looking statements are subject to certain risks and uncertainties. Actual results, performance, or achievements may differ materially from those expressed or implied. Information is based on data gathered from what we believe are reliable sources.

Using diversification as part of your investment strategy neither assures nor guarantees better performance and cannot protect against loss of principal due to changing market conditions.

Past performance is not a guarantee of future results.

The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra Investment Services, LLC or Kestra Advisory Services, LLC. This is for general information only and is not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation.

Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment Advisory Services offered through Kestra Advisory Services, LLC (Kestra AS) an affiliate of Kestra IS. CD Wealth Management and Bluespring Wealth Partners LLC* are affiliates of Kestra IS and Kestra AS.  Investor Disclosures: https://bit.ly/KF-Disclosures

*Bluespring Wealth Partners, LLC acquires and supports high quality investment adviser and wealth management companies throughout the United States.

The Build Back Better Act that was so widely discussed at the beginning of the year has come to fruition in the form of the Inflation Reduction Act of 2022, which President Biden signed into law Tuesday. Its objective is to reduce inflation and the deficit, lower drug costs and increase investment in domestic energy production. The outcome of the Inflation Reduction Act will not be known for years to come, of course, but we want to discuss how some important parts of it may affect you.

What’s in the Inflation Reduction Act?

1. The bill introduces a 15% minimum corporate tax that applies to companies generating more than $1 billion in annual profit (based on a three-year average). Congress’ Joint Committee on Taxation estimates that fewer than 150 companies will be subject to the new rate. At the same time, there is a new 1% tax on stock buybacks. A stock buyback, or share repurchase, occurs when a company buys outstanding shares of its own stock to reduce the number of shares available on the open market. One reason companies may do this is to increase the value of the remaining shares available. It is an investment a company makes in itself when it believes its shares are trading too cheaply in the open market. The new 1% tax goes into effect in 2023, which could cause some companies to speed up buying shares this year and “tilt future capital deployment toward dividends,” Wells Fargo says.  

2. The act has the potential to save retirees a significant sum of money on healthcare costs. It allows Medicare to negotiate prices for certain drugs for the first time in 2026 — starting with 10 drugs, then expanding the list to 15 drugs in 2027 and 20 in 2029. The act caps out-of-pocket drug costs at $2,000 a year for Medicare beneficiaries, starting in 2025. Today, there is no cap on what people may spend. The act also caps insulin costs at $35 per month for those on Medicare. Additionally, all vaccines will be covered under Medicare part D. According to a recent study by the Center for Retirement Research, retirees spend about 25% of their Social Security on medical expenses, including Medicare premiums and out-of-pocket costs for prescription drugs.  

3. The Inflation Reduction Act allocates $80 billion over 10 years to increase IRS enforcement on taxpayers with more than $400,000 in income, with the goal to catch more tax cheaters. It is widely believed that this will dramatically increase the need for labor in our country, but with the unemployment rate at 3.5%, the question is: Where will the IRS find the new auditors needed?

Expected Results from the Inflation Reduction Act

REVENUE
15% corporate minimum tax: $313 billion*
Prescription drug pricing reform: $288 billion**
Enhanced IRS tax enforcement: $124 billion**
Total revenue raised: $725 billion

INVESTMENTS
Energy security & climate change investment: $369 billion***
Affordable Care Act extension: $64 billion**
Total investments: $433 billion

TOTAL DEFICIT REDUCTION: $292+ billion

^{* Joint Committee on Taxation, ** Congressional Budget Office, *** Both}

4. The largest investment made by the Act relates to energy security and climate change, with billions of dollars going to expand wind and solar power production. Additional subsidies will be available for purchases of electric vehicles as well as funding for people to install energy-efficient heating and cooling systems in their homes. However, new rules make the EV tax credit harder to get, as there are limits as to the percentage of production that must occur in North America for the cars as well as for batteries. The credit is unavailable if the taxpayer’s adjusted gross income exceeds a threshold amount ($300,000 for taxpayers filing a joint return, $150,000 for single filers). There also is money available to oil companies to reduce greenhouse gas emissions and penalties for those that fail to do so.  

No one can predict the long-term results of the Inflation Reduction Act of 2022. The good news is that inflation appears to be easing on its own as global supply chain disruptions ease and the Federal Reserve’s tightening of money supply is working. There is little debate, though, that this bill will help reduce the deficit. Retirees stand to benefit heavily from the future reduction in drug costs. The legislation stands to create the single largest investment in climate and energy in the U.S. to date: roughly $369 billion, with estimates of cutting emissions by as much as 40% by 2030. At the end of the day, though, we won’t know for many years how the Inflation Reduction Act affects inflation or corporate profitability.

The CD Wealth Formula

We help our clients reach and maintain financial stability by following a specific plan, catered to each client. 

Our focus remains on long-term investing with a strategic allocation while maintaining a tactical approach. Our decisions to make changes are calculated and well thought out, looking at where we see the economy is heading. We are not guessing or market timing. We are anticipating and moving to those areas of strength in the economy — and in the stock market. 

We will continue to focus on the fact that what really matters right now is time in the market, not out of the market. That means staying the course and continuing to invest, even when the markets dip, to take advantage of potential market upturns. We continue to adhere to the tried-and-true disciplines of diversification, periodic rebalancing and looking forward, while not making investment decisions based on where we have been.

It is important to focus on the long-term goal, not on one specific data point or indicator. Long-term fundamentals are what matter. In markets and moments like these, it is essential to stick to the financial plan. Investing is about following a disciplined process over time.

Sources: CNBC, Investopedia, Financial Planning Magazine, Kestra Investment Management

This material contains an assessment of the market and economic environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. Forward-looking statements are subject to certain risks and uncertainties. Actual results, performance, or achievements may differ materially from those expressed or implied. Information is based on data gathered from what we believe are reliable sources.

Using diversification as part of your investment strategy neither assures nor guarantees better performance and cannot protect against loss of principal due to changing market conditions.

Past performance is not a guarantee of future results.

The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra Investment Services, LLC or Kestra Advisory Services, LLC. This is for general information only and is not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation.

Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment Advisory Services offered through Kestra Advisory Services, LLC (Kestra AS) an affiliate of Kestra IS. CD Wealth Management and Bluespring Wealth Partners LLC* are affiliates of Kestra IS and Kestra AS.  Investor Disclosures: https://bit.ly/KF-Disclosures

*Bluespring Wealth Partners, LLC acquires and supports high quality investment adviser and wealth management companies throughout the United States.

As we approach the end of the year, now is a good time to take a closer look at required minimum distributions (RMDs). Required minimum distributions apply to retirement accounts such as IRAs, SEP plans and Simple IRAs, as well as 401(k)s, 403(b)s, 457(b)s, profit-sharing plans and other defined contribution plans. Money that is invested in retirement accounts is not tax-free; it grows tax-deferred over time, and the government has rules about when it must be taken out. 

What are RMDs?

Once you turn 72 years old, you are required to take minimum distributions from your traditional IRAs and most employer-sponsored retirement plans. You can always take more than the minimum amount if you choose. You also can take money out of your retirement account before age 72 (penalty-free after age 59½). However, there is a minimum amount that must be taken each year at age 72, whether you have taken money out before that age or not. Failing to take the full amount of the RMD could result in a penalty tax of 50% on the difference. For example, if your RMD is $5,000, and you fail take that amount out of your plan, you could face a $2,500 penalty!

Generally, RMDs must be taken by Dec. 31 each year. You are allowed to delay the first RMD until April 1 after the year in which you reach RMD age — but in that case, you will need to take two RMDs in one year, with the second coming by Dec. 31. Taking two distributions in one year might bump you into a higher income tax bracket, so this often is not the recommended approach.

How much do I have to withdraw each year?

The amount changes each year, according to your age. The first step is to calculate the Dec. 31 balance for your retirement accounts. Next, find your age in the IRS uniform lifetime table and the corresponding distribution period. (The distribution period is an estimate of how many years you will be taking RMDs.) Divide the balance by the distribution period to determine the RMD. In the example below, the ending balance of the retirement accounts is $958,405. At 74 years of age, the distribution period is 23.8. Therefore, the RMD would be $40,269, the minimum amount that must be withdrawn from the accounts for the year. This amount is taxed as ordinary income. 

You are allowed to take the entire RMD out of one account, even if you have several retirement accounts, or you can take it from several retirement accounts — as long as you withdraw the required minimum amount in total.

Exceptions to RMDs

There is one exception when it comes to 401(k) RMDs. If you are still working for the company sponsoring your plan by the time you turn the required age and you don’t own 5% or more of that company, you may be able to avoid RMDs. However, not all plans allow this, so you need to double-check with the plan administrator. Once you leave the company, you will need to start taking withdrawals from your 401(k). Please keep in mind that this exception applies to 401(k)s only.  If you have an IRA in addition to your 401(k), you will need to take your RMD regardless of whether you are still working or not.

Recent RMD rule changes and complexities

The SECURE Act of 2019 raised the RMD age from 70½ to 72 beginning in 2020. That means if you reached age 70½ before 2020, you are currently taking RMDs. Then came the pandemic, and in 2020, Congress passed the CARES Act. One of the purposes of this act was to help individuals manage financial challenges brought on by the pandemic, and RMDs were waived for 2020 — including any that were postponed in 2019. Please note that RMDs have resumed for 2021 and must be taken this year; the CARES Act applied to 2020 only.

The IRS has issued new life expectancy tables designed to help investors stretch their retirement savings over a longer period. These new tables take effect for RMDs beginning in 2022. What does this mean for you? This will typically lead to lower annual RMD amounts and potentially lower income tax obligations. However, if the portfolio balance of your retirement accounts continues to grow, then the amount you must take as a distribution also may continue to grow.

How to minimize the tax impact of RMDs

An individual donor can contribute up to $100,000 per year in qualified charitable donations (QCDs) if the individual is 70½ or older. In married couples, each spouse can make QCDs up to $100,000 for a potential total of $200,000. QCDs can be made only to certain qualified charitable organizations; they cannot be made to donor-advised funds. If a donor makes a QCD that exceeds the individual’s RMD, the extra distribution cannot be carried over (i.e., used to meet the minimum distribution in following years).

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So, what can we learn from all this? An RMD is the smallest amount you must withdraw from your tax-deferred retirement accounts every year after a certain age. If you have multiple retirement accounts, you can withdraw money from each account or from one account, as long as you withdraw the total required minimum. Each dollar withdrawn as part of the RMD is ordinary income. If you have charitable donations and are over the age of 70, using part or all of your RMD can be a great planning tool. (You will need to make sure the funds go directly from the retirement account to the charitable organization.)

From a portfolio perspective, we continue to adhere to the tried-and-true disciplines of diversification, periodic rebalancing and looking forward, while not making investment decisions based on where we have been. Making market decisions based on what might happen may be detrimental to long-term performance. The key is to stay invested and stick with the financial plan. Markets go up and down over time, and downturns present opportunities to purchase stocks at a lower value. As we say each week, it is important to stay the course and focus on the long-term goal — not on one specific data point or indicator.

It all starts with a solid financial plan for the long run that understands the level of risk that is acceptable for each client. Regarding investments, we believe in diversification and having different asset classes that allow you to stay invested. The best option is to stick with a broadly diversified portfolio that can help you to achieve your own specific financial goals — regardless of market volatility. Long-term fundamentals are what matter.

Sources: Fidelity, AARP, Broadridge

This material contains an assessment of the market and economic environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. Forward-looking statements are subject to certain risks and uncertainties. Actual results, performance, or achievements may differ materially from those expressed or implied. Information is based on data gathered from what we believe are reliable sources.

Using diversification as part of your investment strategy neither assures nor guarantees better performance and cannot protect against loss of principal due to changing market conditions.

Past performance is not a guarantee of future results.

The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra Investment Services, LLC or Kestra Advisory Services, LLC. This is for general information only and is not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation.

Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment Advisory Services offered through Kestra Advisory Services, LLC (Kestra AS) an affiliate of Kestra IS. Kestra IS and Kestra AS are not affiliated with CD Wealth Management. Investor Disclosures: https://bit.ly/KF-Disclosures

Last week, President Biden announced the framework for the “Build Back Better” spending bill and outlined the plan to pay for it. The proposed bill stands at roughly $1.75 trillion, far less than the original $3 trillion. The social spending package focuses heavily on climate change, green energy provisions, childcare programs, expanded Medicare benefits and health care coverages, and universal kindergarten.

The chart below summarizes how the spending package would be funded: a new 15% minimum tax for corporations, a tax on corporate stock buybacks, investing in the IRS to boost enforcement, and a new surtax of 5% on individual income greater than $10 million with an additional 3% on income greater than $25 million.

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Surtax on wealthy individuals: A 5% surtax would apply to individuals with income over $10 million. An additional 3% surtax would apply to income over $25 million.

Corporate tax rate: The House bill proposed a new top corporate tax rate of 26.5%. That was replaced in the compromise bill with a 15% minimum tax to ensure that no corporations can use loopholes and incentives in the tax code to pay a lower rate.

Individual income tax rates: The House bill proposed increasing the top rate from 37% to 39.6% for individuals over $400,000 in income, but the proposal was dropped from the compromise bill.

Capital gains: The House bill proposed a new top rate on capital gains and dividends of 25% for individuals with more than $400,000 in income (vs. the current 0%, 15%, and 20%, depending on income), but the proposal was dropped from the compromise bill.

Estate tax: The House bill would have dropped the amount of inherited assets exempt from the estate tax from the current level of $11.7 million to about $6 million, but the proposal was dropped from the compromise bill.

Roth IRA conversions: The House bill would have prohibited Roth IRA conversions for both traditional IRAs and employer-sponsored plans for taxpayers with incomes above $400,000, but the proposal was dropped from the compromise bill.

Roth conversion limits: The House bill would have prohibited Roth IRA conversions for wealthier taxpayers beginning in 2032. That provision was dropped from the compromise bill.

Cap on aggregate retirement account balances: The House bill proposed that individuals with more than $10 million in tax-advantaged retirement accounts would be required to take required minimum distributions (RMDs), regardless of their age. That proposal was dropped from the compromise bill.

Billionaires’ tax on unrealized gains: An idea was floated in the Senate to levy an annual tax on unrealized gains for individuals with $1 billion or more in assets. But the plan did not attract enough support and was scrapped.

State and Local Tax (SALT) Deduction: A group of lawmakers has been pushing to increase the $10,000 cap on the deduction for state and local taxes, which was imposed in 2017. While the provision was not included in the compromise bill, these lawmakers have said that they will continue to push for an increase in the cap. Democratic leaders have not yet ruled that out.

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For investors, the big news is that almost all the proposed tax increases that would have affected income, capital gains and estate taxes were dropped. Both the House and the Senate still must pass the revised bill, so more changes could be coming. We will continue to watch this very closely, and we will keep you apprised of major developments. If the bill passes, most individuals will not see any tax increases.

The new tax plan appears to pose less of a risk to equities than the plan that previously had been proposed. Even with all the talk of potential equity valuations, hyperinflation and Fed tapering, money has continued to flow into bond funds in comparison to equity funds, as the chart below shows. Over the last 12 years, bond funds have seen inflows of $3.34T, compared to equity inflows of only $.36T. If the fund flows were to reverse and equity inflows caught up with bond fund inflows, the equity markets could sustain the current rally.

So, what can we learn from all this? We continue to believe that it is better to plan than to predict. Building a plan to achieve one’s financial goals across a range of outcomes is the best practice, rather than being solely focused on what may happen if taxes increase.

From a portfolio perspective, we continue to adhere to the tried-and-true disciplines of diversification, periodic rebalancing and looking forward, while not making investment decisions based on where we have been. Making market decisions based on what might happen may be detrimental to long-term performance. The key is to stay invested and stick with the financial plan. Markets go up and down over time, and downturns present opportunities to purchase stocks at a lower value. More and more noise is creeping into the markets today – worries about inflation, higher energy prices, slower growth, possible stagflation, etc. 

The amount of liquidity in the markets remains at record levels. While questions do exist today about the state of the economy, many positives remain about our global economy. As we say each week, it is important to stay the course, focusing on the long-term goal and not on one specific data point or indicator.

It all starts with a solid financial plan for the long run that understands the level of risk that is acceptable for each client. Regarding investments, we believe in diversification and having different asset classes that allow you to stay invested. The best option is to stick with a broadly diversified portfolio that can help you to achieve your own specific financial goals — regardless of market volatility. Long-term fundamentals are what matter.

Sources: Investment Company Institute, Schwab

This material contains an assessment of the market and economic environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. Forward-looking statements are subject to certain risks and uncertainties. Actual results, performance, or achievements may differ materially from those expressed or implied. Information is based on data gathered from what we believe are reliable sources.

Using diversification as part of your investment strategy neither assures nor guarantees better performance and cannot protect against loss of principal due to changing market conditions.

Past performance is not a guarantee of future results.

The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra Investment Services, LLC or Kestra Advisory Services, LLC. This is for general information only and is not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation.

Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment Advisory Services offered through Kestra Advisory Services, LLC (Kestra AS) an affiliate of Kestra IS. Kestra IS and Kestra AS are not affiliated with CD Wealth Management. Investor Disclosures: https://bit.ly/KF-Disclosures