Tag: income tax

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Taxes on Cryptocurrencies

In our post last week, we showed how the risk of cryptocurrencies appears much higher than the risk of stocks and bonds. This week, we will discuss some of the taxes on cryptocurrencies, and how they differ from buying and selling an ETF.

various cryptocurrency on table
Photo by Roger Brown on Pexels.com

Taxing gains and losses

When trading an ETF in a taxable account (e.g. not an IRA or Roth IRA account), trades are generally subject to taxes much like that of a stock. So, gains that are realized after holding for less than a year are taxable as ordinary income. However, to reduce taxes owed on these gains, an investor can offset them with realized losses on other ETFs. Termed tax-loss harvesting, such an approach can have significant economic benefits. But, what if the investor wishes to buy these ETFs they just sold because they anticipate it to appreciate again?

Wash Sale Rules

Selling, then rebuying, an ETF within 30 days violates the Wash Sale Rule. Consequently, such a violation means that the loss on the ETF investment can not be claimed for tax reasons, effectively eliminating the opportunity to tax-loss harvest. But, based on experts cited in this recent CNBC article, wash sale rules do not apply to taxes on cryptocurrencies. The article does caution that some caveats do apply. It suggests that selling a cryptocurrency one day and buying it again the next could still enable tax-loss harvesting. Given the recent wild swings in cryptocurrency prices, and recent gains in some ETFs, investors may wish to consider this tax-loss harvesting approach.

Free and Premium Portfolios Now Available

Lastly, this post is a reminder that the latest free and premium optimal portfolios are now available for your review. So, please log in and see how the latest market conditions have affected these ETF portfolios. 

Note:  This post has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.
ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
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Measuring cryptocurrency risk

Cryptocurrency risk is well known to be very high for many reasons. However, both individual and institutional investors continue to evaluate it as part of their investment portfolios. This post discusses recent cryptocurrency trends in a diversified portfolio and how the risks of this alternative investment compare to mainstream investments like stocks and bonds.

Volatility estimates

Volatility is one common way of assessing the risk of any investment. For the stock market, we provide a historical perspective, updated daily, to see how volatility changes over time for the stock market. But, how does this volatility compare to investments in cryptocurrency? The chart below shows a 3-month annualized volatility for the last several years of the stock market, measured with the ETF IVV, the bond market, measured by the ETF AGG, and the crypto market, measured by the Grayscale Bitcoin Trust  (GBTC). As this chart shows, bond volatility is the lowest, averaging between 3-4%. Stock volatility is higher, averaging between 15 – 20%. Cryptocurrency risk is about five times higher than stocks, with average volatility between 90-100%.

3-Month Annualized Volatility of the stock, bond, and cryptocurrency markets. Source: ETFMathGuy.com
3-Month annualized volatility of the stock, bond, and cryptocurrency markets. Source: ETFMathGuy.com

How much to allocate to cryptocurrency?

This recent WSJ article provided some guidance for individual investors interested in investing in cryptocurrency. While the answers to this question really depend on the individual’s risk tolerance, this article suggested between 1-2%. So, even if the value of the crypto investment hits $0, the investor limits their loss to this original investment amount. But, given the high levels of volatility, more frequent rebalancing may be prudent. Thus, if there is a substantial increase in the price of a crypto investment, the targeted 1-2% allocation would most likely require selling some of the crypto gains.

Unfortunately, selling short-term gains can be “expensive”, especially for those individual investors in a higher income tax bracket. In this case, the use of a Roth IRA may be the best approach. Why? An investor can realize Roth IRA gains tax-free if taken after age 59 1/2 from an account open for more than five years.

ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
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Three Tips on Your Retirement Drawdown Strategy

Below are a few excerpts from my recent article published on the Pepperdine Business Blog. I hope you find these tips helpful when developing your retirement drawdown strategy, whether you are nearing or already in retirement.

Sources of Retirement Income

Your retirement income will differ in several ways from your working income. For many retirees in the U.S., social security will provide a “base” of income, and starts between ages 62 and 70.  Since the U.S. government keeps track of life expectancy, it is not surprising that retirees will receive smaller monthly social security payments if they begin drawing down social security at a younger age.  So, one drawn strategy could be to delaying social security until age 70, which can provide more income if the retiree expects to significantly outlive their peers.

Retirees often have many sources available to meet their retirement income needs.
Retirees often have many sources available to meet their retirement income needs.

To supplement social security, many retirees also employ a drawdown strategy to their taxable, tax-deferred (e.g. 401(k)s) and tax-exempt accounts (e.g. Roth IRAs). The Common Rule is the most common strategy, that begins by taking Required Minimum Distributions (RMDs). Then, the Common Rule draws funds from one account until no assets remain. This strategy then moves to the next account

Your heir’s tax rate

Extending portfolio longevity or increasing your heir’s inheritance requires some thought to your heir’s tax rate. Why? Tax-deferred accounts are more valuable when drawdowns occur at lower tax rates. So, if your heirs expect to have a high amount of taxable income, then it is usually more tax-efficient for you, the retiree, to draw down the tax-deferred account each year up to, but not exceeding, your heir’s tax rate. This drawdown strategy, which includes an assumption of your heir’s tax rate, is embodied in our free online calculator.

Click here to launch the Optimal Retirement Income Calculator by ETFMathGuy.
Click here to launch the Optimal Retirement Income Calculator by ETFMathGuy.

June 2021 ETFMathGuy Portfolios

As a final note, thank you to all of our premium subscribers! You can now access the June optimal portfolios, based on data through May 28th, 2021. Please note we built these ETF portfolios using our latest backtesting results.

ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
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Retirement taxes under Biden or Trump

With the U.S. presidential election less than three weeks away, now is a good time to consider how your retirement taxes may change. In this post, we highlight the differences in Biden Vs. Trump plans for retirees.

The 2020 Presidential Election may change your retirement tax planning.
The 2020 Presidential Election may change your retirement tax planning.
Note:  This post has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.

Income Taxes in Retirement

Most retirees face some amount of income tax. Social security benefits, pensions, interest on CDs, and bond coupon payments are just a few sources of that can produce retirement income tax. Any voluntary withdrawals from and IRA or 401(k)s, or taking required minimum distributions (RMDs) can also trigger income tax.

The Tax Cut and Jobs Act of 2017 established the current seven income tax brackets, with the lowest at 10% and highest at 37%. Both candidates wish to keep these tax cuts in place, which currently plan to lapse after 2025. But, Biden wishes to alter it so that households making more than $400,000 would pay higher taxes by limiting the value of itemized deductions. He also proposes to increase the top tax rate from 37% to 39.6%. For household making less than $400,000, Biden hopes to increase the standard deduction. Doing so should decrease taxable income and, subsequently, decrease taxes owed.

Capital Gains Taxes in Retirement

Current U.S. tax law states that qualified dividends and long-term capital gains from investments held for more than one year are taxed at a lower rate. Excluding the net investment income tax, the maximum rate is 20%. Trump has suggested lowering this rate to 15%. Biden wishes to tax long-term capital gains at income tax rates for households with over $1,000,000 in taxable income. He also plans to eliminate the step-up in cost basis realized by retirees wishing to pass highly appreciated assets to their heirs.

The SECURE Act and your retirement objectives, by DiLellio and Kinsman (2020), Vol 23, Issue 2, The Graziadio Business Review

What doesn’t appear likely to change

There are several areas of retirement taxation that likely won’t change. For instance, I recently published a peer-reviewed article about the SECURE Act. This law passed with broad bipartisan support, delays the onset of RMDs for younger retirees and changes rules for inherited IRAs.

For now, we encourage you to seek out a retirement calculator, like ours at ETFMathGuy, and we wrote about recently, to see what current U.S. tax law means to your retirement plans. We will update our calculator as tax law for retirement income changes.

ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
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Excess Retirement Income Now Included In Our Retirement Income Calculator

We just finished upgrades to our optimal retirement income calculator to include the possibility of having excess retirement income. This situation occurs when Required Minimum Distributions (RMDs) + other non-discretionary sources of retirement income exceed the retiree’s needed income in current and future retirement years. Indeed, this is a good problem to have! It typically occurs when annual retirement income needs are small relative to all the retiree’s income sources. Retirees in this situation have an extremely low risk of outliving their assets.

Click here to launch the Optimal Retirement Income Calculator by ETFMathGuy.

For example, consider a retiree who needs $100,000 of income in their first year of retirement. What should a retiree do if their RMDs are $40,000, pension and social security benefits are $50,000, and interest + dividends in taxable accounts are $20,000, for a total of $110,000? Note: This $10,000 of excess retirement income occurs without taking voluntary withdrawals from any of their accounts. How should a retiree invest this money to maximize tax efficiency?

Retirement Income Sources

As we show on our updated FAQ page, we included many possible sources of retirement income. To help simplify the model, we previously required dividends and interest in taxable accounts to only satisfy immediate retirement income needs. We make a similar assumption of social security and any pension benefits. Put another way, we wouldn’t re-invest these funds for later use in retirement. Thus, the taxable account maintains a single cost basis from investments made prior to retirement.

What about Required Minimum Distributions (RMDs)?

Required Minimum Distributions (RMDs) complicate retirement income planning, and represent non-voluntary account withdrawals. They can also produce the unintended consequence of producing excess retirement income, like in the example above.

Tax Efficient Investing of Excess Retirement Income

We upgraded our model with a simple approach to reinvesting excess retirement income that would never be needed by a retiree. As previously advocated by DiLellio and Ostrov (2020) and DeMuth (2020), zero-dividend equity (e.g. stock) investments offer a solution. For example, the largest zero-dividend ETF is the First Trust Dow Jones Internet Index Fund (ticker: FDN). By reinvesting excess income into an ETF like this one, no gains during retirement would be realized. So, no taxes are due. Then, the total amount in this investment account can be passed to the retiree’s heirs tax-free thanks to a step-up in cost basis, but excluding estate taxes. Below is an image that shows the new black line to track the account holding the excess income that, in this example, starts in year 7.

In this example, excess retirement income starts in year 7, and is reinvested in a zero-dividend ETF for maximum tax efficiency.
In this example, excess retirement income starts in year 7, and is reinvested in a zero-dividend ETF for maximum tax efficiency.

We hope you find this new enhancement helpful in planning for your retirement! Please stay tuned for future enhancements to our web-based calculator, including evaluating the benefits of municipal bond ETFs, Roth conversions, and automating sensitivity analyses.

ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
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Finding your Optimal Retirement Income

We introduced a new feature to ETFMathGuy.com in 2019 to help current and future retirees plan for the future. We have now upgraded it to find optimal retirement income. Fortunately, the calculator still offers answers to the many commonly posed questions for those nearing or currently in retirement.

  • How long will my portfolio support my discretionary and non-discretionary expenses?
  • How much will my heir or favorite charitable organization receive?
  • What will my future tax liabilities look like?

This calculator models income tax, capital gains taxes and other important elements of U.S. tax law relevant to individuals and couples in retirement. However, this model does not represent tax advice, and is for educational purposes only.

Sequencing Withdrawals for Optimal Retirement Income

In the former version of our calculator, we only applied the so-called “Common Rule“. Using values for a hypothetical 60-year old couple with a 20 year retirement horizon, the figure below shows how the couple can achieve $150,000 of annual after-tax retirement income. Notice how this “married filing jointly” couple has a effective 0% income tax bracket, as labeled on the right of the figure, due to use of the standard deduction. In 2020, this value is $24,800. To re-create these results or create your own, please visit our our interactive retirement calculator.

Common Rule withdrawal sequencing leading to a $1,203,938.01 inheritance. optimal retirement income
Common Rule withdrawal sequencing leading to a $1,203,938.01 inheritance.

While the “Common Rule” is widely adopted by financial planners and major discount brokers like Fidelity and Vanguard, it is known to sub-optimal. Why? This rule typically produces very little tax burden in the earlier years of retirement, unless they are triggered by Required Minimum Distributions (RMDs). Consequently, later retirement years can see very high income tax to maintain retirement income at acceptable levels. This rule also doesn’t take advantage of the step-up in cost basis realized by the retiree’s heirs.

Optimizing Retirement Income Withdrawal Decisions

The latest version of the retirement income calculator can now optimize withdrawal decisions using an “Optimal Rule“. So, using the same values for the calculator as our previous hypothetical couple, their heir’s inheritance increases by 13.7%, or $165,000. If their heir is a qualifying charitable organization, the inheritance increases by  $335,343.94 or 26.1%. We encourage you to try out your own scenarios to see how you can improve your retirement withdrawal decisions.

Optimal Rule withdrawal sequencing leading to a $1,368,938.05 inheritance, a 13.7% increase. optimal retirement income
Optimal Rule withdrawal sequencing leading to a $1,368,938.05 inheritance, a 13.7% increase.

Plans for the Future

We have plenty of other plans for our retirement calculator. For instance, delaying social security, including tax-free municipal bond interest, and assessing the benefits of a Roth conversion are just a few. If you have any thoughts of what you would like to see, please send us your feedback!

ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
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The SECURE act and Your Retirement

On December 20, 2019, the SECURE act (Setting Every Community Up for Retirement Enhancement act) was signed into law. This new law made a number of changes that could effect your plans for retirement. We discuss a few highlights of this new law in this post.

New age for Required Minimum Distributions (RMDs)

The SECURE act recognizes that more individuals are delaying retirement. So, the new law changes the age to take initial RMDs from tax-deferred accounts, like 401(k)s, 403(b)s and traditional IRAs. Previously, initial RMDs were triggered in the year you turned 70 1/2.

Required Minimum Distributions (RMDs) are changing.
Tax laws for retirement are changing. source: Getty Images

The new age under the SECURE act is 72 for individuals who reach 70 1/2 in 2020. Using a handy online age calculator or performing a little mental math, that means anyone born after June 30, 1949 can wait until the year they turn 72 to take RMDs.

How will this new RMD age affect your retirement plan?

In late 2019, we developed a retirement calculator that included income and capital gains tax forecasts. It also included RMDs under the old law. We are happy to announce we have updated our calculator to include this new law. Please check it out! We also added a tool tip for each input in the calculator, to help you better understand how the model works.

We updated our retirement calculator to include the age change of RMDs from 70 1/2/ to 72.

Bad news with the SECURE act

Unfortunately, there is also some bad news for retirees coming from the SECURE act. The so-called “Stretch IRAs” are now not nearly as valuable as they were prior to this law. Previously, IRAs that are passed to nonspouse heirs could be withdrawn over their life time. This feature made inherited IRAs very appealing to younger heirs, who could stretch their payments, limit their income taxes, and stretch pre-tax gains over a longer time. The new law limits this time to 10 years. In a bit of good news, this law does not affect existing inherited accounts.

Conclusions

Tax law will continue to change. We shouldn’t expect congress to continue to keep the taxes status quo. Instead, current and future retirees should consider diversifying their retirement income sources to accommodate possible future changes.