First Grexit, Then Brexit, Now Itexit?

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The future of the EU is in question again- for the 3rd time in 4 years. In June 2015, the Greek financial crisis brought us Grexit. Two years later, the Brexit vote passed. And, now we may have Itexit. The political turmoil in Italy could result in Italy renouncing the euro and reviving the lira. Italy was a founding member of the EU and its exit could cause severe economic disruptions worldwide.

The two parties that won the March 4th Italian elections, the Five Star Movement and the League, have been hostile toward EU rules and the interference by Brussels in Italy’s affairs. They joined forces to form a government and proposed euroskeptic Paolo Savona as their choice for economics minister. Mr. Savona co-authored a blueprint for Italy to leave the EU. Current Italian President Sergio Mattarella rejected Mr. Savona and effectively collapsed the attempt to form a government. Mr. Mattarella’s Democratic Party has supported staying in the EU and was a big loser in the spring elections. Now, it looks like new elections later this summer are likely, which could amount to a referendum on Italy remaining in the EU.  

In 2015, Greek voters overwhelmingly rejected EU bailout terms requiring austerity. Greece defaulted on some of its debt and ultimately agreed to a third bailout, worth $100 billion, which imposed further cuts on spending. Grexit proved to be a powerful force for the Eurozone to work together and develop closer ties and more consistent and tougher fiscal rules. Greece is on schedule to be free from the burden of bailouts in August.

The UK is scheduled to withdraw from the EU on March 29, 2019, with a 21 month transition period out to December 31, 2020. Despite delays in negotiations, the UK government and UK opposition party say Brexit will happen. Since Brexit, the British pound first slumped, then regained its losses against the U.S. dollar, but has remained down 15% to the euro. Bank of England Governor Mark Carney indicated that Brexit has reduced UK GDP by $60 billion already. There is an ongoing debate as to what the relationship between the UK and the EU will be post-Brexit. If there is no agreement on trade, the UK would operate with the EU under World Trade Organization rules, which could mean customs checks and tariffs on goods as well as longer border checks. It could also mean Britain losing its position as a global financial center and its citizens living in other parts of the EU will lose their residency rights and health insurance. The next negotiation summit will be this June.

Before the euro, Italy had the power to raise or lower interest rates on their currency to impact its value. A cheap lira made Italian exports less expensive around the world, strengthening their economy at home. But, with the euro, Italy has no control over interest rates or prices. The populists, who did well in the recent elections, complained that their spending power has declined with the euro and EU membership has undermined Italian sovereignty. However, now Luigi di Maio, leader of the Five Star Movement, has said his party never supported leaving the euro.

Many experts agree that if Italy left the euro, it would be poorer, likely default on its debts and the lira would become greatly devalued. A default could lead to retribution from other countries and potential asset freezes and economic isolation. If this occurred, the trustworthiness of the euro as a currency would be questioned and the impact could destroy confidence in the EU itself.

Let’s hope Italy stays in the EU. The UK is starting to realize that the populism that brought Brexit can be quite expensive and painful. The Greeks certainly didn’t like austerity, but the tough rules of the EU put their country in a better spot. Itexit would harm Italians, the EU and the world. Let’s hope if there is a referendum, the Italians will vote for the greater good and stay in the EU.

Supreme Court Overturns Ban on Sports Gambling

NBA slot machine

On Monday, the Supreme Court struck down the 1992 federal law that said states couldn’t “sponsor, advertise, promote, license or authorize” sports gambling. The ruling in Murphy vs. NCAA agreed with New Jersey that the law was an intrusion into states’ rights to regulate activity within their borders. NJ had waged a six-year battle against the NCAA, NBA, NFL, MLB and NHL to allow sports betting. NJ will now join Nevada as the two states with legalized gambling. More will certainly follow. Illinois and South Carolina have already introduced bills and are moving towards legalization.

The states, the leagues and lots of others are all licking their chops to participate. The American Gaming Association estimates that $150 billion is wagered every year on illegal bets. Now, sports gambling could become more widespread, more systematic with an even larger market. Mark Cuban, owner of the Dallas Mavericks, believes that the overall value of sports franchises has doubled overnight. “It will increase interest in the arena or stadium, it will increase the viewership for customers online, and help traditional television networks.”

The NBA has discussed with state officials what it calls an “integrity fee” of 1% on all betting. The integrity fee would be needed, in part, to pay for more assistance to league officials to keep the league honest, thus policing players and coaches so that games are not “thrown” to win bets. MLB has proposed a .25% integrity fee. Ted Leonsis, owner of both the Washington Capitals and Wizards, said that the sport franchises need to be paid “equitably” for the content and “intellectual property” they provide to television.

Pennsylvania last year passed legislation to allow sports betting, which included a 36% tax on sports betting revenue. Nevada’s rate is 6.75%. While some states may resist on moral grounds (Utah’s anti-gambling stance is written into its constitution), most will jump on the bandwagon as soon as possible. It has been estimated that $245 billion in legalized sports betting could generate $16 billion in additional state tax income.

Sports data companies, like Sportradar and gambling companies, like MGM and Caesars Entertainment, are hoping to cash in. The betting public can now come out of the “underground” market. Legal bookmakers should do well-Nevada sportsbooks haven’t had a losing month since 2013.

And what about the players and their salaries? If the NBA received a 1% fee, under the current union contract, half of that would be owed to the players. So, if $50 billion of NBA related sports betting produced a $500 million “bonus”, half of that would go to the players. And, this extra money might raise the salary cap and cause crazy gyrations with many top players changing teams.

However, there’s only so much money to go around. Last year, Nevada’s sportsbooks had a 5% profit margin, according to the state’s gaming board. A 1% “integrity fee” would represent 20% of the profit. With everyone fighting for their piece of the pie, legalized gambling may not take off as quickly as expected.

Joe Asher, chief executive of William Hill US, part of a major British sports betting operation, cautions that tax rates and league fees could add to the complexities: “It’s not going to be easy to move customers from the black market into the legal market.” Time will tell.

Put Longevity into Your Planning

We’re living longer.  Back in 1935, when Social Security was started, there were 8 million Americans 65 or older.  Today, there are 50 million and by 2060 there will be 100 million 65 and older. It is projected that in 2033, the population of 65 and older will, for the first time, outnumber those under 18.

In addition, there is a better than average chance that 65 year old investors with at least $1 million of investable assets will reach age 100. These folks not only have enough money to cover rising costs, they are also generally more physically fit, healthier and engaged.  BTW- May is Older Americans Month, with a theme of “Engage at Every Age.”

Longevity is having and will have a huge impact not only on social security but also on long-term financial planning.  The trust fund for social security retirement benefits is expected to be depleted by 2034.  After that, the program is projected to pay out about 75% of benefits.  At that time, the ratio of workers paying into Social Security, as compared to those receiving benefits, is projected to drop from 2.8 now to 2.1 then. Last month, Ginny provided information on social security including possible fixes http://www.dwmgmt.com/blogs/142-happy-national-social-security-month-.html.  We hope Washington will enact some appropriate changes soon, though we can’t control that process.

We can, however, control our own financial planning.  Here are some general tips on incorporating longevity into your planning:

  1. Plan based on living longer. For those of you in great health, use an eventual age past the actuarial age, perhaps even age 100.  Your plan may end sooner, but let’s make sure the plan is designed for you to have sufficient funds during your life time.
  2. Plan on your normal retirement expenses continuing until at least age 90. Most older Americans we know are engaged. They are working and volunteering, traveling, mentoring, learning, and participating in activities that enrich their physical, mental and emotional well-being.  Don’t expect your normal expenses to start declining before age 90.
  3. Plan on health care costs escalating faster than inflation. Investors worldwide agree that health expenses are their biggest financial concern related to longevity. This worry is most acute in the U.S. with 69% listing it as their number one worry, versus 52% globally.  We are currently using 6% as the estimated annual increase in health care costs in our planning for clients.
  4. Review your long-term care strategy early. Long-term care costs can be huge.  On the other hand, your plan might “end” without you ever needing long-term care.  What would be the cost and best way to insure? Should you self-insure?  Should you keep your current policy?  Should you modify it?  Every financial plan needs to address long-term care and develop an appropriate strategy.
  5. Use an ample estimate for inflation. Inflation can have a huge impact on expenses over a long period of time.  You should stress test the plan at inflation rates above 2%, such as 3% or higher.
  6. Use a realistic real return for investments. The real return for your investments is defined as your total return (which is the price change over the period + dividends/interest) less inflation.  From 1950 to 2009, the real return was 7%; composed of an 11% total return less 4% inflation.  Of course, the 50s, 80s and 90s all had double digit real returns.  Today, it’s a good idea for you to stress test your plan projections using lower real return assumptions like 2.5% to 4%, depending on your time horizon and asset allocation.
  7. Consider separating travel goals into two parts. When you are retired and mobile, your travel will likely be primarily for you (and your significant other) and may include your children and/or grandchildren. As you get older and can’t travel easily yourself, you might still provide a second travel goal to cover transportation of the kids and grandkids to come visit you.
  8. Don’t count on too much from Social Security. We work with successful people of all ages.  We think that long-term social security benefits may be subject in the future to some “means test,” perhaps the same way that Medicare Part B premium costs are tied to taxable income.  The younger you are now and more financially successful you are in your life will likely reduce the amount of social security you will eventually receive.  If you are not starting social security soon, consider using discounted values of future social security benefits in your planning.
  9. Work to have a planning graph that doesn’t go “downhill.” Our financial goal plans show a graph of portfolio value over time, beginning now until your plan ends.  If expenses and taxes exceed income and investment earnings in any year, then the portfolio declines.  If that situation continues, then the graph looks as if it is heading “downhill.”  A solid plan results in the graph moving uphill over time or at least staying level.  A solid plan therefore reduces anxiety about longevity as, year by year, the portfolio value stays “solid” without diminishing.

 

Just like possible changes in social security, none of us can control our future health or when our plan will end.  We can however, develop, monitor and maintain a long-term financial plan that will provide us with the best chances for financial success by recognizing the possibilities of longevity and incorporating it into all aspects of our planning.  We can also adopt and/or confirm an objective to “Engage at Every Age” for our own well-being, as well as making a difference in other’s lives.   If you have any questions, please give us a call.

 

Signatures are Becoming Extinct

Later this month, Visa, Mastercard, Amex, Target will no longer require signatures to complete credit card transactions. Walmart and other credit card companies and retailers will soon follow. It’s a new ball game now that cards are embedded with computer chips. Signatures are becoming extinct. Personal checks are on their way out. Could genuine handwritten notes be next?

Signatures have been part of our human identity and creativity for thousands of years, dating back to the Sumerians and Egyptians. The English Parliament elevated the status of signatures in 1677 by enacting the State of Frauds in 1677 Act which required all contracts to be signed. By 1776, when John Hancock signed the Declaration of Independence, the signature was in its full glory for binding a contract and exhibiting the signer’s creativity. Fast forward to 2000 when President Bill Clinton signed the E-Sign Act paving the way for eSignature technologies to use digital signatures to sign contracts.

Credit card companies, which cover the costs of credit card fraud, started adding microchips more than a decade ago to reduce fraud. Prior to chips, most retailers required signatures on all purchases and could be held liable (for a fraud) if they failed to notice that the signature on the receipt did not match the one of the back of customer’s card.

Then, with online shopping, card networks started the transition to eliminate signatures. Typically, purchases less than $25 or $50 did not require signatures. However, some card issuers continued to require signatures, so many merchants just kept getting signatures on all transactions. Now, with chip technology leading the way, the card networks are indicating that signatures are obsolete. This will speed up the checkout line, which will make everyone happy.

Some merchants may continue to ask for signatures. Some believe customers have the signature built into their muscle memory of the purchasing process. Further, they are concerned that eliminating signatures might impact workers’ tips. Lastly, some like to keep the signature as evidence that the customer received the services or goods when fighting fraud claims.

Even so, signatures are becoming extinct and will be likely be reserved for special situations, like a house purchase, a marriage license or birth certificate. Even celebrity autographs are now being replaced by “selfies.”

Which leads us to genuine handwritten notes. We know how important a handwritten “Thank you” or sympathy card is. Like homemade bread and hand-knitted socks, handwritten notes make a huge impact. Unfortunately, all of us are pressed for time. Not to worry, you can now fake a handwritten note using online services:

Handiemail. You type a letter, send it to Handiemail with the address of the recipient and $10. Within a couple of days, your letter, handwritten on specialty paper and hand-addressed in a premium envelope with a first-class stamp is delivered.
Inkly. With Inkly, you select a card design, type your message, snap it with your phone, upload to the app and Inkly sends it out for you.
Bond. Starting at $3, you can send an elegant handwritten note with a choice of five handwriting styles to be delivered to the recipient in a suitably classy envelope. Also, for $500 you can visit a Bond HQ where staff will help you improve your own handwriting.
Handwrytten. This is another app which offers a range of classy cards, which the company considers “hipster-friendly, limited-print letterpress designs.” Each letter created has “truly organic effect.”
Yes, keyboards seem to be replacing pens. A recent study showed that one of three respondents had not written anything by hand in the last six months. On average, they had not put pen to paper in the last 41 days. With information technology, handwritten copy is fast disappearing.

However, there is some pushback. Pens and keyboards apparently bring into play very different cognitive skills. “Handwriting is a complex task which requires directing the movement of the pen by thought,” according to Edouard Gentaz, professor development psychology at the University of Geneva. He continues, “Children take several years to master this precise motor exercise.” On the other hand, operating a keyboard is a simple task; easy for children to learn.

In 2000, work in the neurosciences indicated that mastering cursive writing was a key step in overall cognitive development. Studies have also shown that note-taking with a pen, rather than a laptop, gives students a better grasp of the subject.

IT continues to change our world. Yet, Professor Gentaz believes that handwriting will persist, “Touchscreens and styluses are taking us back to handwriting. Our love affair with keyboards may not last.” Time will tell.

Our Children Are Our Future

This Holy Week in the Christian world is an excellent time to put last Saturday’s “March for Our Lives” in perspective. While millions of Americans found the marches for gun control inspiring, many others were skeptical wondering “What do these kids know?” Older people have been groaning about the young in politics for centuries. Yet, in the late 19th century, during a very dark political time for the U.S., the young people helped save democracy. Can they do it again?

Young people have always been involved in American politics, primarily as unpaid labor doing work behind the scenes; making posters, handing out campaign information, running errands and other unglamorous jobs. The young were never allowed to champion themselves or their opinions, being told by established politicians to simply follow the party’s platform.

At the end of the 19th century, according to John Grinspan, Smithsonian historian and author, young people cried out to be heard on their issues. A new generation of young people denounced current leaders and partisanship. They demanded reforms. In 1898, one New Yorker summarized their movement as “the younger generation hates both parties equally.”

At the start of the 20th century, the youth movement put an end to extreme polarization; forcing both parties to pursue its issues and concerns. Independent young voters became a decisive third force, with enough clout to swing close elections. Politicians supported them and their agenda, creating the Progressive Era, which included cleaning up cities and passing laws protecting workers. Though unable to personally vote, women played a key role. Women worked to refocus American life toward social issues, built schools and fought child labor.

Mr. Grinspan argues that the key to understanding youth politics is that young people can’t “focus simply on benefits for the young.” Youth is temporary and gains are passed on. The high school seniors who marched Saturday across the country will hopefully make their schools safer well after they have graduated. Mr. Grinspan concludes that the young should set the nation’s political agenda as they will be here much longer than the rest of us.

Today’s young have much work to do. The solutions the marchers want certainly depend on winning elections. Ultimately, it’s not about standing up to be heard, but about accomplishing political change. These kids didn’t spontaneously emerge from Florida a month ago. They and millions like them were born after 9/11. They have grown up with the worry of guns in their classrooms and the threat of terrorism for their entire lifetime. Many have perceived that our grown-up generations have been stripping our nation’s resources, allowed or assisted in the destruction of the middle class, added trillions of dollars of debt to our nation’s finances and have allowed politics to sink into tribalism. They’ve been watching us and our mistakes and they’ve decided it’s not for them. We all have much to learn from these children and their perspective and they deserve our support.

In honor of Holy Week, it seems a very appropriate time to read Matthew 19:13-14 (from the new living translation): “Then the little children were brought to Jesus for Him to place His hands on them and pray for them; and the disciples rebuked those who brought them. But Jesus said, ‘Let the children come to me. Don’t stop them! For the Kingdom of Heaven belongs to those who are like these children.’”

DWM wishes you and your family a wonderful Easter weekend!!

HOW TO AVOID A 2018 INCOME TAX SHOCK

Did your paycheck get a nice bump in the last few weeks? Employers are just starting to use the newly issued IRS withholding tables for 2018. All things being equal, employees may see a 5%-15% reduction in their federal tax withholding, resulting in a boost in their take home pay. Who doesn’t love that? However, the question is, when you file your 2018 tax return a year from now, will you owe a substantial amount? Has your withholding been reduced too much? How do you avoid a tax shock?

The various changes of tax reform passed in December plus lower withholding may lead to unexpected results. Itemized deductions were generally reduced; in some cases, in major ways. Standard deductions were doubled. Income tax rates were lowered. Exemptions were eliminated. Lots of moving pieces to consider.

Let’s take a look at an example, as presented by the WSJ last Saturday. Sarah is a New York resident. For 2017, she had $200,000 of wages and other income and $33,000 of itemized deductions, including $28,000 for state and local income taxes. Her federal tax, including AMT, was $41,400. Her withholding was set at $41,500, so that she would receive a tax refund of about $100.

For 2018, Sarah has the same income and deductions, and she doesn’t adjust her withholding certificate, even though her itemized deductions are reduced by $18,000 to $15,000. Using the 2018 withholding tables and her withholding certificate (W-4) from 2017, her employer reduces her withholding and increases her take-home pay by $5,300, about $100 per week.

Here’s the problem: Because her deductions were greatly reduced and she lost her personal exemption, her income taxes will only be reduced by $500 in 2018. She’ll owe $4,700 (plus a penalty for underpayment) come April 2019.

All taxpayers, even those that don’t get paychecks, need to get ahead of curve and project their income taxes for 2018 and review how tax reform is going to impact them. You need to do it early. Sarah can change her withholding now (by increasing withholding $100 per week-back to what it was) to avoid a big tax shock in April 2019. In addition, as you and your tax professional review the elements of your 2018 projection, you may identify some changes that made now could reduce your ultimate 2018 income taxes.

The IRS has put together a withholding calculator, https://www.irs.gov/individuals/irs-withholding-calculator that seems to work fairly well with simple returns. It’s a “black box” with little detail of the calculations.

At DWM, we consider our role in tax planning a very important element of the value we provide to our Total Wealth Management clients. We don’t prepare returns. However, since our inception, we’ve been doing projections focused on eliminating surprises and often finding potential tax savings ideas to review with our clients and their CPAs. This year we are using BNA Income Tax Planner software to make sure that all the new tax provisions are being considered and calculated properly as we are doing the projections. We’ve done about dozen so far.

We’ve already seen some major eliminations of itemized deductions on projections we’ve done. One couple lost over $100,000 of itemized deductions, primarily due to the new $10,000 cap on state and local income taxes and elimination of miscellaneous deductions. Similar to the example above, without a change in their W-4s and, therefore, a change in their withholding, they would have owed over $30,000 in federal taxes in April 2019.

Tax reform didn’t have much impact on IL income taxes, as taxes are passed primarily on adjusted gross income. However, the full year tax rate of 4.95% in IL is roughly 16% more than the effective 2017 rate. In SC, where the state tax is based on taxable income, the tax will generally be going up for those taxpayers with large itemized deductions in the past. SC tax in 2018 will likely rise at the rate of 7% of the amount of lowered deductions and exemptions as compared to 2017, all other items being equal.

We encourage you to prepare or get assistance to prepare a 2018 income tax projection now and check it in the fall as well. Even if you haven’t received a larger paycheck recently, it’s really important to go through this process to avoid tax shocks and, maybe, even find some opportunities to reduce your taxes for 2018.

DOW 26,000-WHEN’S THE LAST TIME YOU THOUGHT ABOUT YOUR RISK?

With U.S. stocks at all-time highs, now is the perfect time to review your risk profile and then make sure the asset allocation within your investment portfolio matches it.  Equity markets have been on a tear.  In 2017, the average diversified US stock fund returned 18%, while the average international stock fund returned 27%.  In the first three weeks of 2018, the MSCI World Index of stocks has increased 5.6%. With low interest rates and inflation, accelerating growth and the recent passage of the Tax Cuts and Jobs Act, it looks like this streak could continue in 2018.

During the current nine year bull market, investor emotions about stocks have gone from optimism to elation and many investors now are not only complacent, but overconfident. Yet, with valuations soaring, we are approaching the point of maximum financial risk.  Certainly, at some point, we will have a pullback, correction or crash.

It always happens.  It could be a conflict in N. Korea or Iran or somewhere else.  It could be a worldwide health scare.  It could be higher interest rates negatively impacting our rising national and personal debt.  It could be something none of us even consider today.  History shows it will happen.  We need to be ready for it by having an asset allocation in our portfolios that matches our risk profile.

What exactly is a risk profile?  There are three components of your risk profile.  First, your risk capacity, or ability to withstand risk.  Second, your risk tolerance, or willingness to accept large swings in investment returns.  It’s the way we are hard-wired to respond to volatility.  Third, your risk perception, or short-term subjective judgment about the characteristics and severity of risk.

We classify your risk profile into one of five categories of risk: defensive (very low), conservative (low), balanced (moderate), growth (high) and aggressive (very high).  As a general rule, younger investors are more willing to take on a higher level of risk.  However, that’s not always true.  Investors in their 80s and 90s who know that they have ample funds for their lifetimes and beyond, and who can emotionally handle high risk, may have an aggressive risk profile, particularly when they plan to leave most of their money to the beneficiaries.  Everyone’s circumstances and emotions are different.  Profiles can change over time, particularly when there are life changing events, such as marriage, birth of a child, loss of job, retirement, changes in health or other matters.  Therefore, it’s important to regularly assess your risk profile.

Here’s the process:

 

Step 1. Quantify your lifetime monetary goals and compare those with your expected lifetime assets. During your accumulation years, how much will you add to your retirement funds per year?  How many years until retirement?  How much money will you need to withdraw annually during retirement for your needs, wants and wishes?  What are your sources of retirement income?  What’s your realistic life expectancy?  What market return is required to provide the likely outcome of success- not running out of money?  Do the goals require a high rate of return just to have a chance of success or is the goal so low risk that even a bad market outcome won’t cause it to fail?

Risk capacity isn’t simply the amount of assets you have; rather it is the comparison of those assets to your expected withdrawal rate from your portfolio.  A low withdrawal rate from your portfolio, e.g. 1% or 2% a year, means you have high risk capacity. A high withdrawal rate, such as 6% or more, means you have low risk capacity.

Step 2.  Evaluate your tolerance for risk.  What’s your comfort level with volatility?  Are you aggressive? Moderate?  Defensive? How does that compare to the risk needed in your portfolio to meet your goals?  If the risk needed to meet your goals exceeds your risk tolerance, you need to go back and modify your goals.  On the other hand, if your risk tolerance exceeds the risk level to meet your goals, does that mean you need to take on more risk just because you can or because you can afford it? You need to go through the numbers and make important decisions.

Step 3. Compare the risk in your portfolio to your risk tolerance.  Separate your assets into all three classes: equities, fixed income (including cash) and alternatives and determine your asset allocation.  A balanced portfolio might have roughly 50% equities, 25% fixed income and 25% alternatives.  An aggressive (very high risk) portfolio could have 80% equities and a defensive (very low risk) portfolio might have only 10-35% equities.  If your portfolio is riskier than your risk tolerance, changes need to be made immediately.  If your portfolio risk is lower than your risk tolerance, you still need to make sure it is of sufficient risk for you to meet your goals, considering inflation and taxes.

Step 4.  Rebalance your portfolio to a risk level equal to or less than your risk tolerance and sufficient to meet your goals.  Make sure you diversify your portfolio within asset class and asset style. Diversification reduces risk.  Reducing portfolio expenses and taxes increases returns. Alternatives are designed to reduce risk and increase returns. Trying to time the market increases your risk. Set your asset allocation for the long-term and don’t change it based on feelings of emotion. Stay invested.

Step 5.  Most importantly, regularly review and monitor your goals, risk profile and the asset allocation within your portfolio.  The results: Improved lifetime probability of financial success and peace of mind.

TAX REFORM: THIS YEAR’S CHRISTMAS GIFT OR A FUTURE CHRISTMAS COAL?

On top of the regular holiday season’s festivities, this year we’re watching the proposed “Tax Cuts and Jobs Act” likely making its way to the President’s desk for signature. The “joint conference committee” announced yesterday that they have a “final deal” and Congress is scheduled to vote on this next week.  Before we review what we specifically know about the bill (not all details have been released as of this morning) and provide some recommendations concerning it, let’s step back and review it from a longer-term perspective.

Since last year’s election, stock markets have been on a tear- up over 20%, mostly driven by increased corporate profits, both here and abroad.  U.S. GDP is growing and unemployment is close to 4%.  Most economists believe that now is not the time for a tax cut, which could heat up an already expanding economy to produce some additional short-term growth and inflation. The Fed reported yesterday that the tax package should provide only modest upside, concentrated mostly in 2018 and have little impact on long-term growth, currently estimated at 1.8%.  So, tax cuts now will not only likely increase the federal deficit by $1.5-$2 trillion over the next decade, but will take away the possibility of using tax cuts in the future, needed to spur the economy when the next recession hits.  Certainly, we would all like lower ta

xes and even higher returns on our investments, but we’d prefer to see longer-term healthy economic growth with its benefits widely shared by all Americans and steady investment returns, rather than a boom-bust scenario and huge tax cuts primarily for the wealthy that may not increase long-term economic growth.

As of this morning, December 14th, here are the current major provisions:

Individual

  • Income Tax Rates.  The top tax rate will be cut from 39.6% to 37%.
  • Standard deduction and exemptions.  Double the standard deduction (to $24,000 for a married couple) and eliminate all exemptions ($4,050 each).
  • State and Local Income, Sales and Real Estate Taxes.  Limit the total deduction for these 

    to $10,000 per year.

  • Mortgage Interest.  The bill would limit the deduction to acquisition indebtedness up to $750,000.
  • Limitations on itemized deductions for those couples earning greater than $313,800.  Repeals this “Pease” limitation.
  • Roth recharacterizations.  No longer allowed.
  • Sale of principal residence exclusion.  Qualification changed from living there 2 of 5 years to five out of eight years.
  • Major items basically unchanged.  Capital gains/dividends tax rate, medical expense deductions, student loan interest deductions, charitable deductions, investment income tax of 3.8%, retirement savings incentives, Alternative Minimum Tax, carried interest deduction (though 3 yr. holding period required.)
  • Estate Taxes.  Double the estate tax exemption from $5.5 million per person to $11 million.

 

 

Business

  • Top C-Corporation Tax Rate.  Reduce to 21% from 35%.
  • Alternative Minimum Tax.  Eliminated.
  • Business Investments.  Immediate expensing for qualified property for next five years.
  • Interest Expense.  Limit on expense to 30% of business interest income plus 30% of adjusted EBITDA.  Full deduction for small businesses (defined as $25 million sales by House, $15 million by Senate).

Another key issue, the top rate on pass through organizations (such as partnerships and S Corps), is yet to be determined. However, it appears that a reduction of 20% to 23% will be available to pass-through income, subject to W-2 minimums and adjusted gross income maximums. This would produce an effective top rate of 29.6% on pass through income.

If all of that see

 

ms confusing, you’re not alone.  Lots of moving parts and lots of details still to be clarified. Even so, if the bill passes, you will have been smart to consider the following:

Recommendations:

1) Because the bill would limit deductions for local income, sales and real estate taxes, you should make sure that you have paid all state income tax payments before December 31, 2017. If you are not sure, pay a little extra.

2) Also, make sure you pay your 2017 real estate taxes in full before 12/31/17. Because Illinois real estate taxes are paid in “arrears” it will be necessary to obtain an estimated 2017 real estate tax bill (generally due in 2018) by g

 

oing to your county link and then paying this before 12/31/17.  Let us know if you need help on this.  In the Low country, while our CPA friends indicate that paying 2018 real estate taxes in 2017 should be deductible, as a practical matter, there appears to be no way to get an estimated tax bill for 2018 and prepay your 2018 real estate taxes in 2017.

3) Meet with us and/or your CPA in early 2018 to review the impact of the Act, assuming it becomes law, on your 2018 income tax planning. It will be important to review the various strategies that may be available to make sure you are paying the least amount of taxes. 

Yes, tax reform may be here before Christmas. Not sure what it will be: a wonderful gift for this year’s holiday or perhaps a lump of coal in our stockings for Christmases to come.  Stay tuned.

Ready for a quick quiz?

financial-literacy-quiz

Two-thirds of the world can’t pass this financial literacy test.  Can you?  You don’t need a calculator, just 3-5 minutes of time.

 

Risk Diversification: Suppose you have some money to invest.  Is it safer to put your money into one business, piece of real estate or investment or to put your money into multiple businesses or investments?

a)One business, piece of real estate or investment

b)Multiple businesses, pieces of real estate or investments

 

Inflation:  Suppose over the next 10 years, the cost of things you buy including housing, food, taxes and health care and all others double.  If your income also doubles, will you be able to buy less than you can buy today, the same as you can buy today, or more than you can buy today?

a)Less

b)The same

c)More

Mathematics: Suppose you need to borrow $100 for one year.  Which is the lower amount to pay back: $105 or $100 plus 3% interest?

a)$105

b)$100 plus 3% interest

Compound Interest:  Suppose you put money into a bank and the bank agreed to pay 3% interest per year to your account.  Will the bank add more money to your account in the second year than the first year, or will it add the same amount of money for both years?

a)The same

b)More

Compound Interest II:  Now suppose you have $100 to invest in a (very aggressive) bank who will pay you 5% interest per year.  How much money will you have in your account in 5 years if you do not remove any of the principal or earned interest from the account?

a)Exactly $125

b)More than $125

c)Less than $125

 

Pretty simple, right.  The answer is b for all.  We’re sure our regular DWM blog readers got them all right.

Across the world, however, the 150,000 people who took the test didn’t do so well.  Two-thirds of them answered at least 2 of the 5 questions incorrectly.  The survey pointed out some key findings.  Norway has the greatest share of financially literate people worldwide.  Canada, the UK, the Netherlands and Germany also finished in the top 10. The U.S. didn’t.

downloadIn the Emerging Market countries, like China, India, Brazil and Russia, the young people, ages 15 to 35 were the most financially literate.  Apparently the kids in Shanghai “knocked the cover off the ball” (just like George Springer of the Astros).

So, what’s the takeaway? Financial literacy for Americans could use improvement.  In addition, as we pointed out in our blog two weeks ago highlighting Nobel Prize winner Richard Thaler, people, even if they are financially literate, can make systematically irrational decisions.  This means you may need a financial coach and advocate.  That’s what we are for our DWM clients.  Whether it’s professional investment management, financial decisions and planning, income tax planning, insurance and estate planning matters, we provide our financial literacy, rational analysis and proactive solutions and suggestions.  It’s our expertise and our passion.  At DWM, this is how we hit home runs!

Nobel Prize Winner Helps Add $30 Billion to Retirement Accounts

Richard Thaler received the Nobel Prize in economics last week, principally by showing that people don’t always behave rationally and, in fact, we are systemically irrational.

Here’s an example: Two friends are given tickets to a basketball game in the Northeast.  The night of the game there is a tremendous snowstorm.  One friend calls the other and suggests there is no way they are going to the game now, in the snowstorm, and they don’t go.  But, he said “You know, if we had paid for those tickets ourselves, we’d be going.”

Studies by Dr. Thaler show that if the friends had paid for the tickets, they would likely driven through the snowstorm because they didn’t want to “lose” their money.  Classical economics would say that’s crazy, but it’s true.  People pay huge attention to “sunk costs,” often irrationally.

Because of Dr. Thaler and others, we know more about human biases and anomalies that impact our financial decisions. These include compartmentalizing (putting money in mental boxes), mental accounting (thinking differently about money in your pocket versus money in the bank) and the endowment effect (once you own something you value it more than before you owned it).

Dr. Thaler not only helped discover our biases but also identified ways to make irrational behavior work to our advantage.  Savings and retirement has always been a big area for him.  He applauds the fact that if we compartmentalize (have a “mental box”) for retirement savings we are doing a very good thing.  Putting money in a 401(k) plan makes it much “stickier” than other money and it stays there.

In 2004, Dr. Thaler and Shlomo Benartzi published “Save More Tomorrow.”  It is based on the idea that instead of asking people to save more now, ask them to save more in the future.   We tend to irrationally discount our future commitments.  Hence, we tend to put off savings because retirement is so distant, but we will commit to future savings because it is also so distant.  Dr. Thaler suggested that people save 50% of every raise.  No need to give up anything now.  And, this concept would mean that if you save 50%, then the remainder will be left for current spending, without any guilt.  Every raise therefore increases both spending and savings- a much more palatable idea than taking away some of our current income to save.

Over the past few decades, most company pension plans have been discontinued and replaced by company sponsored defined contributions plans, where employees needed to make contributions.  These voluntary accounts should have worked better.  Rational employees were expected to save and invest to meet their long-term goals.  But, it didn’t work that way-participation rates early on were very poor.   Dr. Thaler was asked about the problem and his response was that workers can be their own worst enemies- “without help, they’ll never retire.”

His solution: “Nudge” them into joining company retirement plans, using a concept known as automatic enrollment.  Rather than waiting for employees to complete paperwork, companies would automatically enroll them and workers, if they don’t want to be in, can opt out.

Last year, 58% of companies were automatically signing up workers. That’s up from 8% in 2000.  And some companies are automatically escalating the contributions or giving the employees the option to do so.  Thaler and Benartzi’s research shows, as compared to 2011 data, 15 to 16 million more people are saving.  Assuming an average contribution of $2,000 a year, that’s $30 billion a year in additional contributions.

Dr. Thaler, with his colleague Hersh Shiffrin, suggested that our mental accounting of money is often a battle in our brains between the “doer” (focused on short-term rewards) and the “planner” (focused on the long-term.)  How choices are presented to us (“the choice architecture”) makes a big difference in our decision.  Making enrollment in the 401(k) occur by default and requiring a worker to “opt out” will likely put the “planner” in control, not the “doer.”

One of our key jobs and challenges at DWM is to assist our clients by framing questions and choices in the appropriate way.  Like Dr. Thaler, we understand that wealth, health and happiness decisions are not always rational yet we do our best to find a way to “nudge” both your doer and planner parts of your brain in order to help protect and grow your assets and your legacy. We haven’t made a $30 billion impact yet, but we’re passionately working on it every day.