Dear Clients and Friends,
If you are new to The Financierge, our purpose is to discuss some of the latest topics that reflect the diversity of the planning and thought leadership we provide you as part of our wealth management platform. Not only do we guide you through all the phases of wealth accumulation, distribution, and transfer, but we also do so in a context that is holistic and comprehensive. We devote as many resources to being consultative planners as we do to being quality investment managers. To this end, the Financierge provides perspectives across all the services we provide, including investment solutions, financial and retirement planning, accounting, tax, risk management, insurance, estate planning, charitable planning, real estate, business consulting, and family and lifestyle management.
In this month’s issue of The Financierge, you will learn what States are tax-friendly, how retirement income gets taxed, and the current status of tax changes in the Build Back Better Act. Then we talk about ideas to maximize estate transfer and charitable planning strategies before December 31. We also summarize the 2022 commercial real estate market outlook. From there, we discuss how estate planning and insurance both play an important role in managing your risk. Then we close with a reminder to live a balanced life and have fun. Off we go . . .
A State-by-State Look at Taxes on Retirees May Surprise You!
If you are considering moving in retirement because of taxes, it is important to understand state tax rates and the rules for income, sales, property, estate, and other taxes that may impact you in retirement. California is a good example. California has a high 13.3% income tax rate, but that rate is for married joint filers making more than $1,250,738. For middle- and lower-income earners, the rates are much lower. California does not tax Social Security income. Sales taxes are relatively high, but the State’s median property tax rate is not. In the end, California is actually a good state for most retirees when it comes to taxes, thanks mainly to the reasonable income tax rates for ordinary seniors. According to Kiplinger, the most tax-friendly states for retirees include H.I., NV, AZ, WY, AZ, CO, AR, TN, DE, DC, and S.C. Next, tax-friendly states include C.A., ID, MT, LA, MS, AL, GA, FL, KY, VA, GA, and F.L. The least tax-friendly states include N.E., KS, TX, IA, WI, IL, NY, VT, CT, and N.J. Also, I have found that moving isn’t only a qualitative decision, but it is also a qualitative decision. In other words, not only should you consider financial factors such as taxes, but you should also consider the important quality of life factors such as family, friends, community, weather, etc.
How Retirement Income Gets Taxed
Managing tax brackets and understanding how income is taxed in retirement is important to tax reduction planning. The following are a few examples of how your retirement income gets taxed:
- Tax-deferred Retirement Accounts (401K, Traditional IRAs, …) – Contributions reduce taxable income, and the income grows tax-free. Withdrawals are taxed at ordinary income rates. At age 72, you are required (unless you are working and don’t own more than 5% of the company) to start taking minimum distributions.
- Roth IRAs – Contributions are not deductible, but withdrawals are tax-free after your hold your account 5 years and are age 59 ½; otherwise, there is a 10% early-withdrawal penalty on the gains.
- Social Security – Your Social Security income is tax-free unless you have other retirement income, then the amount you pay in tax will depend on your total combined retirement income. For 2021, if your total combined retirement income is less than $25,000 ($33,000 for joint filers), you won’t have to pay taxes on your Social Security. If your total combined income is $25,000 to $34,000 ($32,000 and $44,000 for joint filers), you will pay income taxes on up to 50% of your Social Security benefit. If your total combined income is more than $34,000 ($44,000 for joint filers), you will pay income taxes on up to 85% of your Social Security benefit. This is an essential consideration if you are contemplating when to start taking social security.
- Pensions – Pensions are usually funded with pretax income, so your pension income is taxed as ordinary income.
- Stocks, Bonds, and Mutual Funds – If you sell investments that you’ve held for a year or less, the gains are short-term and are taxed at your ordinary-income tax rate. If you sell stocks, bonds, or mutual funds that you’ve held for more than a year, the proceeds are taxed at long-term capital gains rates of 0%, 15%, or 20%, depending on your taxable income. For 2021, the 0% rate applies to individuals with taxable income up to $40,400 ($80,800 for joint filers). The 20% rate starts at $445,851 for single filers ($501,601 for joint filers). The 15% rate is for individuals with taxable incomes between the 0% and 20% break points. There’s also a 3.8% surtax on net investment income (NII) on top of the 15% or 20% capital gains rate for single taxpayers with modified adjusted gross incomes over $200,000 (joint filers over $250,000). This 3.8% extra tax is due on the smaller NII or the excess of modified AGI over the $200,000 or $250,000 amounts. NII includes dividends, taxable interest, capital gains, passive rents, annuities, royalties, etc.
- Annuities – If you purchased an annuity that provides income in retirement, the portion of the payment that represents your principal is tax-free, and the rest is taxable at ordinary income rates. If you bought the annuity with pretax funds (such as from a traditional IRA), 100% of your payment would be taxed as ordinary income tax rate, not the preferable capital gains rate.
- Dividends (Our Favorite) – If you own stock, either directly or through mutual funds, dividends paid by companies for these stocks are treated for tax purposes as qualified (most common) or non-qualified. Qualified dividends are taxed at long-term capital gains rates. Non-qualified dividends are taxed at ordinary income tax rates.
- Mutual Funds – Municipal bond interest is exempt from federal tax. Also, interest from bonds issued in your home state is typically exempt from state income taxes (but check your own State’s laws). However, capital gains can be subject to federal tax if you sell municipal bonds.
- Savings, Checking, C.D.s, Money Market Accounts – Interest is taxed as ordinary income.
The Current Status of the Build Back Better Tax Changes
As of December 12, 2021, here is what we are tracking:
- No Increases in Top Marginal Tax Rate from 37% to 39.6%.
- No Increase in Top Capital Gains Tax Rate from 20% to 25%.
- No Reduction in Estate and Gift Tax Exemption – The current $11.7 million estate and gift tax exemption is set to expire at the end of 2025.
- No Changes to Grantor Trusts or Family Limited Partnerships.
- No Qualified Business Income Deduction (QBI) Limitation.
- No Billionaire Tax.
- Child Tax Credit – The child tax credit is extended and increased. The maximum credit amount increases from $2,000 per child to $3,600 for a child under age 6 ($3,000 for a child aged 6-17) for head of household tax filers making less than $112,500 and joint filers making less than $150,000. It also allows families to claim their 17-year-old children for the credit for the first time. The credit is fully and permanently refundable.
- State and Local Tax (SALT) Deduction – The SALT deduction lets you taxpayers who itemize to deduct their aggregated State and local taxes on their annual tax return. Currently, there is an $80,000 cap for deductions of state and local taxes. The $10,000 cap will return in the 10th year. This is retroactive to 2021. This is expected to be amended in the final version of the bill.
- Surtax on High-Income Earners – The proposed legislation includes a 5% surtax modified adjusted gross income (MAGI) in excess of $10 million for individuals. There is also an additional 3% surtax on MAGI in excess of $25 million. The surtax threshold for Trusts & Estates is at $200,0000 (5% surtax) and $500,000 (additional 3% surtax).
- Contribution Limits on Large Retirement Plans – The bill adds several provisions for large balances in tax-deferred retirement plans. One restriction prohibits high earners in the top tax bracket from making new contributions to a traditional IRA or Roth if the total value of an individual’s IRA and defined contribution retirement accounts generally exceeds $10 million as of the end of the prior taxable year. The proposal also increases the required minimum distributions for high earners whose combined qualified accounts exceed $10 million. In addition, the bill proposes to eliminate a strategy called “backdoor” Roth conversions for high earners.
- Roth Conversions – Roth conversions of after-tax funds in retirement accounts would be prohibited for all taxpayers starting in 2022. Also, Roth conversions are prohibited for taxpayers in the highest ordinary income tax bracket starting 2032.
- Retirement Plans – Effective 2029, you must take a Required Minimum Distribution (RMD) for large retirement accounts balances if your taxable income is > $450,000 (joint filer) and combined value of your IRA and defined contribution plans is > $10 million. If combined retirement account balances are between $10–$20 million, you must distribute 50% of the excess. If combined retirement account balances are > $20 million, you must take a 50% RMD, but first distribute the lesser of 100% of the balance above $20 million, or 100% of the balance in ALL Roth Accounts. Also, effective in 2029, traditional and Roth IRA contributions are prohibited if your taxable income is> $450,000 (joint filer) and the total value of your IRA and defined contribution plans is> $10 million. The limitation does not apply to contributions to employer plans such as 401(k), SEP, and pension plans.
- S-Corporations – S-Corp profits (along with distribution from retirement accounts) would be considered investment income and subject to net investment income tax effective in 2022.
- Expanded Wash Sale Rules – The bill proposes a change to the tax treatment of an IRS provision known as the wash sale rule, where you can’t take a deduction for a loss on the sale of an investment if you replaced it with the same or a “substantially identical” investment 30 days before or after the sale. This would also apply to foreign currency transactions, commodities, and cryptocurrency.
Estate & Transfer Planning
Wealth Transfer Strategies to Consider Before December 31
There is still time to maximize wealth transfer. Here are some ideas:
- Annual and Lifetime Exclusion Gifts – For 2021, the annual gift tax exclusion is $15,000 per beneficiary ($30,000 for joint filers). For 2022, this exclusion increases to $16,000 ($32,000 for joint filers). This reduces your estate, and any gifts you make under the current $11.7 million per person exclusion won’t be subject to future estate taxes.
- Trusts – If you don’t want to gift assets outright to your beneficiaries, you may want to consider gifting to a trust account. These accounts allow you to retain a level of control over the gifted assets and protect assets over a beneficiary’s lifetime or when they reach a certain age.
- 529 Plans – 529 Plans are a good way for you to save for a child’s K-12 (up to $10,000) and higher education costs. One of the benefits of using a 529 plan for education is that contributions to these plans are considered gifts for tax purposes. In 2021, you can contribute up to $15,000 per beneficiary ($30,000 per married couple) to a 529 plan without having to pay gift taxes. Even if you contribute more than $15,000 to a 529 plan in a calendar year, you still might not have to pay a gift tax because the excess can count against the lifetime estate and gift-tax exemption (currently, $11.7 million). These excess amounts must be reported on IRS Form 709. If you prefer, you can make a lump-sum contribution of up to five times the annual gift-tax exclusion, or $75,000 this year. If you wait until 2022, when the gift-tax exclusion goes to $16,000, you can make an $80,000 contribution. Although there are no annual contribution limits to 529 plans, maximum aggregate limits are ranging from $235,000 to $550,000, depending on the State. In addition to the federal gift-tax exclusion, many states offer tax benefits on 529 plans. Thirty-four states and the District of Columbia let individuals take a tax deduction or credit up to a specific limit.
- Medical Expenses – Similar to funding educational expenses, you can pay for anyone’s medical expenses tax-free if you pay the provider directly. You can also pay for any legal, medical, and dental costs incurred during a given tax year not reimbursed by insurance.
- Political Organizations – You can make contributions to a political organization defined in Sec. 527(e)(1).
2021 Charitable Ideas Before December 31
There is still time to maximize charitable planning before year-end. Here are a few ideas:
- Give Appreciated Non-Cash Assets Instead of Cash – You can donate appreciated non-cash assets (including publicly traded securities, restricted stock, and private business interests) held for more than one year and generally eliminate the capital gains tax you would otherwise incur if you sold the assets first and then donated the proceeds. This could potentially increase the amount available for charity by up to 20% while increasing your tax savings. Annual income tax deduction limits for gifts to public charities, including donor-advised funds, are 30% of adjusted gross income (AGI) for contributions of non-cash assets held more than one year and 60% of AGI for contributions of cash.
- Leverage a Charitable Deduction – If your itemized deductions for 2021 are below the standard deduction level, it might make sense to combine 2021 and 2022 charitable contributions into 2021, itemize deductions on your 2021 tax returns, and take the standard deduction on your 2022 return.
- Use a Qualified Charitable Distribution – If you are near retirement or reviewing estate plans, you might consider making a qualified charitable distribution (QCD) of individual retirement account (IRA) assets. Whether itemizing deductions or claiming the standard deduction, individuals age 70½ and older can direct up to $100,000 per year tax-free from their IRAs to charities through QCDs. The QCD also reduces the donor’s taxable income in future years, the donor’s taxable estate, and IRA beneficiaries’ tax liability.
- Take an Additional Charitable Deduction – If you are taking the standard deduction, you can take an additional deduction of up to $300 for cash contributions for individual filers and $600 for married couples filing jointly can claim up to $600.
- Qualified Contributions for 100% of AGI – Qualified contributions are cash contribution to qualifying charitable organizations. Your other allowed charitable contribution deductions reduce the maximum amount allowed, and you must make the election on your 2021 Form 1040 or Form 1040-SR.
- Life Insurance – You can donate your life insurance and get a fair market value of the policy or your cost basis, whichever is less when you transfer all ownership rights in policy, subject to 60% of the adjusted gross income limit (30% for private foundations).
- Donor Advised Fund – A Donor Advised Fund (DAF) allows you to make an irrevocable contribution and get an immediate tax deduction within the constraints of your Adjusted Gross Income (AGI), it supports qualified charities now or over time, contributions grow tax-free, and donations can be anonymous. While there are tax advantages of contributing to a DAF, there are other valuable benefits such as organizing your giving better, developing a charitable mission statement, engaging family members, and providing greater support to causes you love.
2022 Commercial Real Estate Market Outlook
Coldwell Banker Richard Ellis (CBRE), one of the world’s largest commercial real estate services companies, expects 2022 to be a record year for commercial real estate investment. The is a result of high levels of low-cost debt availability and real estate debt’s attractive risk-adjusted returns. Here are some highlights from their report:
- A growing economy with fuel commercial real estate’s recovery.
- The pace of inflation will slow, and treasury rates will hold steady.
- Total investment volume in 2022 is projected to increase 5-10% over 2021 levels. Industrial and multifamily assets will likely continue from the tailwinds of e-commerce and demographic shifts, and investment in office and retail assets should also pick up. Hotel volume in the first three quarters of 2021 recovered and is a positive sign for the sector heading into 2022.
- The all-property average cap rate is expected to hold firm and be 280-300 basis points (bps) higher than the 10-year Treasury yield during the first half of 2022, on par with the 290-bps average from 2013 to 2018, before narrowing to 250 bps in the second half of 2022. Rents should continue rising, supporting higher property net operating income (NOI) for most asset types. Although cap rates typically follow the direction of real interest rates, NOI expectations are more influential in the long run in the short term.
- The U.S. office market strengthened in the second half of 2021, and the momentum will likely continue in 2022 but will contend with the highest vacancy in nearly three decades and lower rental rates until the second half of the year.
- The Life Sciences sector will continue growing in key U.S. office markets throughout 2022.
- Retail space is more efficient. Since 2010, sales per sq. ft. of U.S. retail space have risen. From 2010 to 2020, retail sales grew 42 percent, while retail supply grew just 4 percent. Consumer spending is forecast to rise in 2022 as a build-up of personal savings during the pandemic is released. The revival of inbound international travel, responsible for more than $150 billion in expenditures annually, according to a 2019 U.S. Travel Association report, will provide an additional boost to retail in coastal and other tourism-focused markets.
- Third Party Logistics (3PLs) continue to gain market share. 3PLs led industrial leasing activity in 2021 with a market share of 30 percent, compared with 13 percent for e-commerce. 3PLs will expand further in 2022 as companies look to reduce direct logistics costs and avoid the hassle of finding space in record tight markets with limited labor availability. As a result, 3PLs’ market share will increase in most U.S. markets as vacancy rates decline, rents increase, and labor markets further tighten, leading to a projected leasing market share of 35 percent by year’s end.
- Cap rate compression accelerates on industrial assets. Robust investor appetite for industrial assets will push up prices and further compress cap rates across markets and product types in 2022.
- Renters are flowing back to cities. Downtown multifamily properties are filling back up, and occupancy rates are nearing pre-pandemic levels due to fewer restrictions on urban amenities, higher vaccination rates, a growing willingness to use public transit, the reopening of college campuses and more workers returning to the office.
- S. multifamily investment volume is predicted to reach a record of nearly $213 billion in 2021, and at least a 10 percent increase for 2022 to $234 billion.
- Business and international travel will be the recovery catalyst for hotels.
- Resorts and all-inclusive destinations will continue to be strong performers in 2022.
- Data Centers are becoming an ever more important and larger commercial real estate asset class as businesses expand their digital infrastructure.
Why is Risk Management Beneficial?
Quite simply, our risk management services help clients reduce risk in property loss, liability, medical costs, disability, death, long-term care, business continuity, travel, and security threat. Properly designed insurance and estate planning combine to help you protect your wealth. Here are some helpful ideas to make sure you are protected:
- Make Sure You Have an Estate Plan and it is Accessible – First, if you don’t have an estate plan, your State of residence has one for you that will cost your family time, money, and privacy. How about if you become involved in an accident where you are unable to speak or make decisions for yourself? Do you have someone you trust that can talk to doctors and complete medical and financial decisions on your behalf? The best way to protect yourself is to ensure you have a properly executed and accessible Advanced Healthcare Directive. Also, keep in mind, your revocable trust does not protect your wealth from lawsuits and creditors. This is where estate planning with certain types of irrevocable trusts and other properly designed wealth preservation strategies can help protect your wealth.
- Ensure You Have Adequate Property & Casualty Insurance Coverage – One of the most effective ways to protect your family wealth is by carrying adequate insurance. It’s also one of the simplest ways to protect against a lawsuit. Properly designed property and casualty insurance is a must. Also, an umbrella policy is an excellent way to supplement your property and casualty policies and help defend against or settle any lawsuit because of accidents.
- Consider Long-Term Care Insurance – It is estimated that most of us will need some type of home or facility long-term care. Owning a long-term care insurance policy protects the lifestyle of loved ones by allowing wealth earmarked for income to remain untouched.
- Consider Life Insurance – In the event, you go to Heaven early, it may make sense to own temporary term (or permanent whole life) insurance to protect your loved ones. Insurance benefits are tax-free to beneficiaries. Conversely, if you own life insurance and don’t need it, you might be able to sell or surrender your policy.
Just for Fun
Celebrate December and the New Year!
Don’t underestimate the value of fun to balance out your life. Here are some fun days to celebrate in December:
- December 10 – The First Night of Hanukkah
- December 12 – Build a Gingerbread House Day
- December 13 – National Horse Day. Take a horse to lunch!
- December 15 – National Cupcake Day. Sprinkles Red Velvet!
- December 16 – National Chocolate-Covered-Anything Day
- December 18 – National Bake Cookies Day. Take a chocolate chip to work!
- December 24 – Christmas Eve
- December 25 – Christmas Day
Superheroes have only been around since 1938, when Superman was first introduced, followed soon after by Batman, Captain America, Wonder Woman, and others. Here are some fun superhero quotes to ponder:
- We all know the truth: More connects us than separates us. But in times of crisis, the wise build bridges, while the foolish build barriers. – Black Panther, “Black Panther”
- Faith is my sword. Truth is my shield. Knowledge my armor. – Stephen Strange, “Shadows & Light Vol. 2”
- Just because someone stumbles and loses their path, doesn’t mean they’re lost forever. – Charles Xavier, “X-Men: Days of Future Past”
- With great power comes great responsibility. – Spider-Man, “Spider-Man.”
- Now I know. Only love can save this world. So I stay. I fight, and I give… for the world I know can be. This is my mission, now. Forever. – Wonder Woman, “Wonder Woman”
- When the mob and the press and the whole world tell you to move, your job is to plant yourself like a tree beside the river of truth and tell the whole world — “No, you move.” – Captain America, “Amazing Spider-Man #537.”
- Life doesn’t give us purpose. We give life purpose. – The Flash, “Blackest Night #8”
- Dreams save us. Dreams lift us up and transform us. And on my soul, I swear… until my dream of a world where dignity, honor, and justice becomes the reality we all share — I’ll never stop fighting. Ever. – Superman, “Action Comics #775”
- The needs of the many outweigh the needs of the few or the one. – Spock, “Star Trek II: The Wrath of Khan”
At The Bahnsen Group, our objective is to provide you with comprehensive and holistic services to help you grow, protect, and steward your wealth toward a multigenerational legacy of both success and significance. We think about each one of those words and work diligently for you in all we do. Please reach out to me or your Private Wealth Advisor if you have any questions or if there is anything we can do for you.
We wish you and your family a wonderful holiday season and a blessed 2022!
Warm and best regards,
Don B. Saulic, CFP® CPA
Managing Director, Partner