Is it true that not only do you “escape” paying capital gains (and Medicare if applicable) taxes on the gain , but you also get to deduct the full value at the time of contribution?
@aj485
This is an important variable to check. It almost makes sense that living longer costs more i.e. if I have funds for living to 95 things with an earlier death will only be better. Do not make that assumption. My wife is 70 and I am 81. We both come from long lived families. When we ran Monte Carlo scenarios with my living to 95 and Linda 105 funds were fine. Change nothing except I die next week and Linda’s financial situation is very different.
We live in Georgia - no tax on social security and a significant deduction for senior’s income. When I die a $30K tax state tax exemption disappears. Sure we will need less food - but Linda likely will eat more meals out – I enjoy cooking and food shopping.
Bottom line, test high, medium and low for every significant variable - inflation, tax rates, interest rates, etc.
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I increased my cash allocation at the end of 2021 when stocks were expensive and I am now averaging some of that cash back in monthly because stocks are less expensive and, IMO, likely to get cheaper thanks to stubborn inflation and the determination of the Fed to fight it with monetary policy.
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Is that market timing or is it waiting for better prices?
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Yes, the full value of appreciated stock donated to a 501(c)3 charity can be deductible. Of course, there are rules that you have to follow in order to deduct the full value in a single year, like the deduction amount is generally limited to 30% of your AGI for that year.
I will also note that because the standard deduction increased substantially and some types of other Schedule A deductions were eliminated or cut back on with the TCJA, so actually taking advantage of this deduction can be more difficult than pre-TCJA.
Edited to add:
Another point about using the Schedule A deduction to “escape” paying taxes is that unless your other deductions add up to more than your standard deduction, you haven’t really “escaped” taxes on at least part of the stock’s value, since you would have been able to take the standard deduction even without taking the charitable deduction.
And a donation of appreciated stock can push you into paying higher ACA or IRMAA premiums because the value of the stock donated is still added to your AGI, and then is deducted after the fact as a Schedule A deduction. Since ACA and IRMAA calculations are based on AGI before deductions, you should understand if the donation will push you over an IRMAA threshold by even $1. I would also note that NIIT taxes are based on AGI before deductions, so if the donation will push you over the NIIT limit for your filing status, that could trigger an additional tax you wouldn’t be paying otherwise.
AJ
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In my view it is market timing unless you really know more about the future market moves than those people who spend a couple of hundred hours a week studying and running big computer AI programs.
And if you really have the skill set I describe, why would you need to ask us?
I am a buy and hold investor. Just missing a hand full of days in 2009 meant needing years longer to get back the 2008/2009 drop. I am not lucky at picking the bottom as Mark Haynes did.
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I would point out that by doing Roth conversions, you are basically deciding when you want to pay the deferred taxes due on your Traditional accounts. From a lifetime tax planning perspective, it’s probably less than optimal to convert all Traditional accounts, as:
- you are prepaying taxes on any balances that would have been left at your death
- in general, medical costs increase as you approach end of life, and medical cost deductions can often be used to offset most, if not all, taxes on Traditional account withdrawals
- tax law can change significantly, such as with the TCJA. Anyone who did conversions pre-TCJA probably paid higher taxes than they would have had they waited. Of course, if the TCJA rules are not extended, anyone who waits until 2026 or after will likely be paying higher rates than they would have had they done conversions while TCJA rules were in effect.
- while Roth withdrawals are currently tax-free, that doesn’t mean that they won’t be used for means-testing in the future, just like ‘tax-free’ muni bond interest is currently added to AGI when calculating taxability of SS and IRMAA premiums
AJ
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My oversized cash position is intended to serve as a hedge against a deep and sustained recession caused by a Fed that has to raise rates higher and longer than the markets expect. If I am right, I don’t need to time my re-entry. Averaging back in over the next few years will be good enough.
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That strikes me as an “I favor a motherhood and county.” type statement. Does anyone think a hedging/guarding against a long, deep recession is bad?
Now there are few details like what is a deep recession? What is a long recession?
My take on this is 2008/2009 while seriously uncomfortable - not the kind of event worth people changing a good investment plan for. Our last paycheck was dated April 30, 2008. We did not change our 60/40 to 70/30 plan. At that time I had social security income, my wife did not. We did have sufficient cash so that my social security, taxable bond income and S&P 500 mutual fund dividends equaled 18 months spending. Like virtually everyone one of our friends, we tried spending less in the Q4-2008 & Q1-2009 so our cash actually lasted longer.
I am just not smart enough or informed enough to out guess the people who run Wall-street firm – insurance companies, Goldman Sachs, Bank of America, Warren Buffett and the like. Since I have these investment handicaps, it seems to me trying to time the market is a fools errand.
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That seems to be the epitome of timing the market.
And if you are wrong, how are you going to time your re-entry?
AJ
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I always figured a good starting point is what money was going into my bank account. Figuring if it was good enough to live off of while working then it should be enough in retirement. Then adjust it for taxes and work from that.
Some expenses will go down in retirement and some up. It will greatly vary depending on the person. Medical expenses aren’t likely to decline. Others like travel, eating out, clothes, etc. could go up or down depending on your life style and plans.
In my case except for medical I’d expect most costs to go down. And while some could go up in the short term, such as eating out, I’d imagine they will go down as I get older, plus if I had to cut expenses those are easily cut since you can always eat at home.
I have to admit to a “reserve” position with my government TSP but it isn’t cash, instead a combo of stocks and cash.
Now sure what age you plan to retire at but I’ve done the following:
Make a spreadsheet with different columns/rows covering my age from 60 to 70+ and also covering sources of my income. In my case besides social security, we will have 3 different pensions (2 quite small), my core account and then a bridge account to cover until we collect social security.
I now need to adjust the spreadsheet for some inherited IRAs that I have to do RMDs from starting this year and covering the next decade. I need to try and figure out how to do this while minimizing taxes. I also am likely to take another job for the next 6-10 months while we determine a retirement home location.
I think barring medical issues which you can’t do much about, we should be fine although I’ll probably be a bit too conservative in the early years. I’m guessing many are overly conservative in the early goings but no one wants to worry about running out of money.
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If we have a v shaped recovery, my 2/3 still in the market will likely outperform the 1/3 that has been in cash since late 2021 and which is averaging back in now. If I am right, the 2/3 in the market will crash with everyone else, while the cash continues to average back in in a down market.
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Okay, I’m confused. You’re expecting a long deep recession, but you’re already averaging back in when we haven’t even started a recession, at least not according to FRED NBER based Recession Indicators for the United States from the Period following the Peak through the Trough (USREC) | FRED | St. Louis Fed (stlouisfed.org)
Why are you averaging back in now? Seems like you aren’t really convinced of your claim.
AJ
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Determining $$ amount of savings required first day of retirement is a 3 step actuarial process involving time-value-of-money calcs which requires a financial calculator.
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Current salary minus Social Security PIA. This is the present value of required replacement income.
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Grow this amount at the rate of estimated wage inflation over the number of years to full retirement age. This becomes the annual wage inflated need in the first year of retirement
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Use this amount as the first retirement years income and from this determine the present value of this annual payment stream, where N = years of life expectancy, PMT = first year required income, FV =0 assuming no $$ residual at end of life and I = inflation adjusted expected average annual rate of return. From this, calculate present value. This is the amount in savings required the first year of retirement
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I am averaging back in because prices are better than they were a year ago, and I know I can’t time my re-entry perfectly. It’s not a matter of being ‘convinced of my claim’. It’s a matter of managing my money as best I can when faced with, in my opinion, a realistic possibility that inflation will force the Fed to raise rates longer the markets think.
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My intention is not to argue. It is sharing what I am doing with real money in real life and documenting it in real time to hold myself account dot the results, good or bad.
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That pokes at the core of one of the big challenges retirees face — paying their bills. Everyone has bills to pay, and the cash to pay the bills has to come from somewhere. If your costs are low enough that Social Security and any pension you may have can sufficiently cover your costs, it’s one thing. If they can’t, then you need a plan that lets you come up with cash from your portfolio.
As 2022 taught us, stocks go down as well as up. As 2023 is teaching us, just because stocks dropped one year doesn’t mean they will rebound strongly the next year. As a result, even if over the long haul stocks can provide great returns, retirees who need cash from their portfolios need to have a plan that lets them get that cash even in a down market.
This old article of mine shows the risk of a 100% stock portfolio for a retiree that needs to access cash from his or her portfolio: The 10 Most Important Years of Your Retirement Plan | The Motley Fool . Even though the index has since recovered, that’s cold comfort for those hypothetical retirees who are no longer invested in it due to having to pay their bills.
Yet on the flip side, a 100% cash portfolio risks running out of money during a long retirement for all but the few who enter retirement with incredibly strong nest eggs.
So the key is finding the right balance between stocks, bonds, and cash to be able to cover your costs even in a down market while still investing in growth for the longer term part of that retirement.
There are three key things to remember about bonds: 1) they mature and turn to cash; 2) while higher on the financial priority ladder than stocks, they are not risk free; 3) the price of existing bonds tends to drop when interest rates rise.
All that said, the retirement portfolio strategy I’m currently building towards is the following:
- 3-6 months of cash in an emergency fund.
- 5 years in a diversified investment grade bond ladder, with the later maturity rungs being larger than the early maturity ones to provide some buffer for inflation.
- The rest in stocks for longer term growth potential.
The emergency fund is there in case a bond goes bad. The bond ladder is there to generate new cash from the maturing bonds, while still providing the potential for higher returns than cash. The stocks are there for longer term growth potential.
In a normal stock market, the maturing bonds will provide spending cash while interest, dividends, and some stock sales will purchase new rungs on the bond ladder to keep it around that 5 year target.
In a rapidly rising market, more stock can be sold to extend the bond ladder. When rates were near zero, I decided that I didn’t want my bond ladder to grow past 7 years. Now that rates are rising, I might revise that cap — particularly if rates get high enough to compete vs. the stock market’s long-run return potential.
In a falling stock market, the bond ladder can shrink as bonds mature. In all likelihood, I’d continue to use dividends and interest payments to buy new rungs on the bond ladder, but without tapping into stock sales to keep it replenished, it would probably mean that the bond ladder would shrink by 9-10 months after the first down year in the stock market.
With this approach, I figure that it would take an extended market downturn before things got dicey. By following this approach, though, I won’t have to try to predict the market’s near-term moves, just adjust to what it offers. Ultimately, I am still relying on the market’s long-term trajectory to be upwards, but if it isn’t, then I suspect we will likely have bigger problems on our hands.
Regards,
-Chuck
Home Fool
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This ends up running into a big problem during a period like 21/22/23. Let’s say you have 5 years in the bonds, and let’s say suddenly we see ~20% inflation over 2 1/2 years, and the stock market drops in response. That means that your formerly 5 years becomes ~4 years, and you’ve spent for another year plus, and now you have to sell even more stock, at lower prices, to get back up to 5 years in bonds!
Hw is this possible? If inflation is 7%, and spending is 1/5 of the bond ladder over the course of a year, how does it only drop by 9-10 months???
Which is why it’s generally recommended that retirees have a mixed portfolio that includes both bonds and stocks. Personally, I also have preferred stocks and REITs, which are not typically considered to be pure ‘stock’ investments.
I will point out that holding bonds to maturity negates the price risk you bring up. On the other hand, buying bonds that have lower rates than current market rates allows you to purchase bonds that will return more than you paid when you hold to maturity, so the price risk can create an opportunity.
I will also point out that there are ETFs with reasonably low expense ratios that hold bonds set to mature in a specific year, so that you don’t have to deal with the exorbitant bid/spread that is often encountered in purchasing small numbers of enough different issues to be diversified.
AJ
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A very successful investor told me there are two keys to success.
#1. It is important to have a written, detailed, clear plan. Pretty much any investor can follow a clear, detailed, written plan.
#2 It is critical to follow the plan i.e. do not change the plan because you could have done better with a different plan.
All of which says there is more than one good way to invest.
So I will offer an alternative to AJ’s idea above - Avoid sovereign bonds - they are just the markets guess at future inflation. I choose high quality “junk” bonds. Note companies that are flirting with cash flow problems or the likes of shale oil companies. One option is VWEAX.
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