Recently, the Standard & Poor’s 500 (S&P 500) had declined  13.9% from the January peak ¹. Stocks are not the only asset class getting beated down. Year to date, through April, core bond funds were down 9.5%, which, if the year ended in April, would be the worst year ever for core bonds (previous worst was –2.9% in 1994) ². Pair all of this with a swelling inflation rate of 8.5 (Consumer Price Index; March 2022), and an investor can’t be blamed for wondering what to do.

It may be a good time to make lemonade out of lemons by considering a Roth conversion.

Huh?

Roth conversions are when an individual takes a portion of a retirement account that has not yet been taxed (I.e., traditional IRAs) and moves it to a retirement account that is post tax (I.e., Roth IRA). Some qualified retirement plans, such as a 401(k), may allow this, too.

Here are reasons why I believe that Roth conversions can make sense right now:

1. The stock market is on sale. When I go to the store, and I see a special sale on that exact thing I’m looking for, why would I wait for that item to go back up in price before I buy it? When completing a conversion to Roth when the market is down, you get to swap out your investments at a lower tax basis. I’ll provide an example later in this article.
2. Taxes are on sale.³ We are experiencing an extremely favorable tax environment right now. With the Tax Cuts and Jobs Act that is set to expire in 2026, this is could be a good time to realize income.
3. There are no required minimum distributions in Roth IRAs. That is not the case for traditional IRAs. Every year, starting at age 72, investors are forced to take money out of their IRAs, no matter if they need the money or not.

Let’s look at an example to give you a better understanding of a Roth conversion. If an Indiana resident (home state bias on display, here) in the 22% federal tax bracket, and with a state tax rate of 3% (rounded down), converts $50,000 of a traditional IRA to a Roth IRA, their taxable income for the year will increase by $50,000. Assuming they stay in the same 22% bracket* with the $50,000 of additional income from the conversion, the tax liability is approximately $12,500 in federal and state taxes at the time of conversion. Hopefully you are tracking with me so far. The next part of the Roth conversion scenario is where investors can really benefit from this strategy.

It’s important to consider one’s tax bracket. A jump from the 22% tax bracket to the 24% tax bracket, the next one, isn’t a big one, but jumps from the 12% and 24% brackets are big moves.

If a market correction reduces the investment account by 15% and the Roth conversion is completed at $42,500 in value, the federal income tax liability from the conversion would fall to $10,625 yielding a $1,875 tax savings upfront. The caveat is once the funds are held inside a Roth IRA, any future market rebound and appreciation will be free of tax ⁴. The S&P 500 has never not rebounded over some time frame.

Other Considerations

The decision to convert all or a portion of your pre-tax IRA accounts depends upon an individual’s own facts and circumstances. Taxpayers are advised to speak with their tax and financial advisers prior to undertaking a Roth conversion. Some of the additional considerations include:

Sources:

1. LPL Research 

2. LPL Research

3. “Low Tax Rates and What to Do” , Strategence Capital Blog

4. “Everyone is Talking about Roth IRA Conversions and Here’s Why” , Kiplinger

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

Traditional IRA account owners have considerations to make before performing a Roth IRA conversion. These primarily include income tax consequences on the converted amount in the year of conversion, withdrawal limitations from a Roth IRA, and income limitations for future contributions to a Roth IRA. In addition, if you are required to take a required minimum distribution (RMD) in the year you convert, you must do so before converting to a Roth IRA.

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What is the purpose of property taxes?

Property taxes are a primary source of funding for local government units, including counties, cities and towns, townships, libraries, and other special districts including fire districts and solid waste districts. These funds are used to pay for a variety of services including welfare; police and fire; new construction and maintenance of buildings; local infrastructure like highways, roads, and streets; and the operations, including salaries, of the local units of government.

Property taxes are derived from local government spending divided proportionally according to the value of the taxpayer’s property. Per a 2018 study, the statewide average revenue distribution per $1 of property tax is as follows:

•  County: $0.19
•  Township: $0.03
•  City/Town: $0.24
•  School: $0.43
•  Library: $0.04
•  Special Unit: $0.07

(Understanding Your Tax Bill)

How are local tax rates calculated?

Property taxes represent a property owner’s portion of the local government’s budgeted spending for the current year. Local spending is the reason for property tax rate increases – or decreases – depending on local fiscal management. This is why local elections matter, another topic for another day.

How is the value of my property determined?

Indiana properties are valued using mass appraisal techniques. With mass appraisal, your property is looked at in conjunction with other properties in your area. Assessors consider age, grade, and condition. Finally, in a process known as annual adjustment, each year real property sales data is used to determine if the value of properties in your area should change to match the market value found in the sales of recent properties.

How is my tax bill calculated?

Property taxes are simple to calculate – take the assessed value of your property after deductions and multiply it by your local tax rate and that is your gross tax liability. However, there are many other steps that can make this calculation more complicated.

Summary

As you can see, there are several factors that go into the property tax calculation but to simplify your tax bill, if property values and/or local government spending has increased in your area, that could mean you may be seeing an increase in your local property taxes in the near future. With the recent boom in housing prices and fiscal stimulus, many homeowners may be getting an unpleasant surprise with their next property tax bill.

We live in Wells County and our property taxes increased by 17% from 2020 to 2021. However, I cannot complain as our district tax rate was 1.7341% in 2021, which is the 1,445th highest district out of 2,070 districts in the state. If you live in Indiana, you can check this website out to see where your district ranks.

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Enter the donor-advised fund (DAF).

Donor-Advised Funds

A donor-advised fund is an investment vehicle that is managed by a third party. This fund can allow you to make a large charitable contribution in one year and make smaller charitable disbursements over several years. One feature of the DAF is that the taxpayer realizes the tax benefit when the money goes into the account, whereas the smaller charitable distributions may have left one under the standard deduction.

DAFs are more user-friendly than charitable remainder trusts and private foundations and are relatively cheap to establish and maintain. Because of the tax law change and the ease of use, there was a 19% increase in individual DAFs between 2018 and 2019, bringing the total number of DAFs to 873,228 (The Tax Advisor, 2021). Let’s look at an example of how bunching your deductions a DAF could work:

Case Study*

John and Jane Smith enjoy giving to their church and other organizations in their local community. Last year, John received a $30,000 bonus at the end of the year, and they gave $18,000 or 10% of their income to their church and another $2,500 to local charities throughout the year. When they go to file their taxes, their accountant figures that even with their giving last year, the standard deduction of $25,900 was still higher than their itemized deductions. The Smiths do not get to deduct any of the $20,500 that was given to charities.

To maximize their tax situation, the Smiths could have taken the $30,000 year-end bonus and started a Donor Advised Fund to use for future giving. This will allow them to deduct the entire $50,500 charitable contributions ($30,000 initial contribution to the DAF + $18,000 to their church + $2,500 to various other charities) compared to their standard deduction and would save them $5,412 in federal taxes. In the following year, the Smiths will give out of their DAF instead of out of their checkbook.

Items to Consider

• Donation amount: The minimum amount to open a DAF is typically $25,000 and the donor is usually limited to sending checks to their preferred charities larger than $100.
• Fees: It is important to understand all the costs that go into a Donor Advised Fund. The DAF will charge a fee to hold the assets, if you hire an advisor to manage the investments, they will charge a fee, and if the money is invested in a mutual fund or ETF, there is an annual expense ratio that the investment fund company charges. All told, the money inside the DAF could cost between 1.0% – 3.0% of the total assets in the DAF.
• Ownership: Once the money goes into a DAF, technically the assets no longer are owned by the donor. The funds that go into the Donor Advised Fund are irrevocable. The donor can advise which charities receive the grants but cannot reverse the gift back to themselves.
• Type of Asset: Be sure the donor-advised fund can accept the asset you wish to donate. Not only can you set up a DAF with cash, but it may be possible to open a DAF with highly appreciated assets such as a stock, real estate, or a business.
• Income Gains: DAFs work great for someone who wants to frontload a charitable contribution to offset a windfall such as the sale of a business or property

If you are looking for ways to give back to some of the non-profit organizations that you are passionate about and want to make sure you are taking full advantage of the potential tax savings, don’t hesitate to give us a call.

*This is a hypothetical example and is for illustrative purposes only. It is not representative of any specific situation. Your specific situation may vary. We encourage you to seek personalized advice from qualified professionals regarding all personal finance, tax, and legal issues.

Content in this material is for general information only and not intended to provide specific tax, legal, or investment advice or recommendations for any individual. Strategence Capital and LPL Financial do not provide tax or legal advice or services. Please consult your tax and legal advisors regarding your specific situation.

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I recently came across a Wall Street Journal article (“How to Get Your Files in Order” March 3, 2021) that provided a few helpful tips from organizational experts (who knew that was a career), on what you should keep, scan, or shred. A synopsis of that article is below:

Financial Records

This may come to a surprise, but the IRS only recommends keeping copies of your tax returns and related documents for three years. That’s it. It’s okay to shred those returns of the years when you made $4.25 an hour sweeping floors.

When you make home improvements to your residence or a rental, be sure to keep those records for when you sell the property so you can accurately determine your cost basis. Unless you are feeling extra patriotic, there is no need in paying the tax man more than what you legally owe.

Bills & Receipts

Speaking of selling your home, did you know that home buyers can request up to a year of the seller’s utility bills? The article suggested keeping at least a year’s worth of utility bills in a cloud-based database.

It also was suggested to keep record of your car’s maintenance records. I know when I go to buy a vehicle, I always appreciate the seller providing those records. Right or wrong, I get the assumption that the seller took good care of the vehicle if there are service records.

Although the article did not touch on this, I would also suggest keeping records of your medical bills throughout the year. If you have a high-deductible insurance plan, you are eligible to contribute to a health savings account (HSA).  HSAs are wonderful savings vehicles, and it’s possible the funds can be invested. The money that goes into an HSA is tax deductible; grows tax free; and if used for medical purposes, can be taken out tax and penalty free; essentially, HSAs are triple tax free.

Vital and Legal Records

The experts interviewed by the author recommend keeping all original documents on legal and vitals for perpetuity. This list includes birth records, marriage licenses, death certificates, adoption papers, military service records, deeds, titles, Social Security cards, and professional licenses. Keeping copies of physical and electronic versions was recommended; if stored online, be sure they are secure.

Estate Planning

According to the article, “the only document that absolutely has to be a physical copy from an estate planning perspective is a person’s will.” An individual’s last will and testament is considered revoked if the original is burned or torn up.

It is a good idea to communicate to your loved ones and the future executor of your estate where the will is kept, along with any other estate planning documents. If you have Power of Attorney documents in place for health care decisions, it is advisable to provide an electronic version to your decision maker in case of accident for ease of access.

Summary

If you plan on taking the task of getting your files in order, there are some digital tools that can help. Cloud storage that you may already have access to would include Google Drive, Apple iCloud, or Microsoft OneDrive. Here at Strategence, some of our clients use our digital vault that we make available to upload and access important documents. Another helpful tool that I use is a PDF scanner app. This app allows me to take pictures that can be scanned and uploaded directly to the cloud.

Jordan Arnold

The opinions voiced in this article are for general information only and should not be considered an individualized recommendation or personalized investment advice.

All investing involves risk including loss of principal. No strategy assures success or protects against loss.

This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.

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Tie your budget to a relevant timeframe

For example, while an annual budget might be a good idea for a bigger picture view, it’s difficult to put into practice as no two months are alike.  I recommend starting with an annual budget based on your expected income for the year and then breaking it down to monthly or even bi-weekly budget, if that is easier to match your cash flow.  Make sure that you start with paying yourself first.  This means that you set aside a fixed percentage or dollar amount that you would like to save (I’d recommend saving 10-15% in retirement accounts) and then start including all of your expenses.  Budget categories that are often missed that I would recommend including would be car maintenance/replacement, medical expenses, property taxes, and license and registration fees.  I would also include in your 2021 budget a “Stuff I forgot to budget for” line item.

Get granular…and keep the big-picture in mind

The article’s next suggestion is to get even more granular with the budget, such as going from a pay-period-based budget to a daily budget, what the author calls a “micro budget.”  This approach, the author says, is a good approach if you find yourself asking, “where does all my money go?”  Strike a balance between little picture and big picture.  Don’t get too bogged down in the short-term nitty-gritty details, but don’t be too broad.  Daily budgets or “micro budgets” never worked for me but do what’s best for your situation.  Use automatic deductions and transfers to work toward those longer-term, bigger-picture goals, like creating an emergency fund or saving for a big purchase.

Celebrate short-term wins

Don’t only come down on yourself when you blow through a budget category but take time to celebrate those short-term budget wins.  If you’re looking for a good budgeting tool, my wife and I have used YNAB (You Need A Budget) for over a year.  It has some nice reporting features where I can review my spending and see where I over-estimated or under-estimated.  It takes time to refine your budgeting process.  Be gracious with yourself and don’t give up.  Budgeting gives you freedom and peace of mind knowing you are living within your means.

The information provided here is for general information only and should not be considered an individualized recommendation or personalized investment advice.

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