Triple Tax Advantage – Health Savings Accounts

Health Savings Accounts (HSA) are a great benefit offered by most larger employers to their employees and they are the only account that offers a triple tax advantage.  The term triple tax advantage is used for Health Savings Accounts because they have tax advantages in three different forms: 1. Deductions are tax deductible 2. The money grows tax deferred 3. Money can be used tax free for medical expenses.

Eligibility and Contribution Limits – Any taxpayer who participates in a High Deductible Health Plan (HDHP) can contribute to an HSA plan.  The limits for 2020 contributions are $3,550 for individuals and $7,100 for families. Contributions can be made for 2020 up until April 15^th of 2021.  Health Savings Accounts are not eligible for individuals who are currently enrolled in Medicare or those who have any other health coverage.

Benefits of a Health Savings Account

As mentioned before a Health Savings Account has many benefits for individuals and families. Contributions made into an HSA receive a tax deduction in the year they are made even if someone does not itemize deductions on their tax return.  This will lower your gross income in the year the contribution is made and the money in the Health Savings Account is pretax.  Also, if your employer makes a matching contribution or an involuntary contribution into your HSA account these contributions are not included in taxable income for the year they are contributed.  The contributions made to an HSA can be invested and accumulate tax deferred (not taxed in current year) while the money remains in your account.  The investment choices in a Health Savings Account are similar to those in a company 401(k) plan.  Distributions from the HSA may then be tax free as long as they are used towards qualified medical expenses. These three characteristics are why Health Savings Accounts are referred to as having a triple tax advantage. 

Keep in mind that any distribution not used towards qualifying medical expenses will receive a 20% penalty and additional taxes unless the taxpayer has reached age 65.  Two other distinct advantages of the HSA are that the HSA is portable, meaning if you change employers you can move the HSA account to a new employer that offers an HSA. Lastly, the contributions and investment earnings may stay in the HSA year after year and are not required to be distributed. This can be used as another form of a retirement savings because the money does not have to be distributed in a certain year if you do not have qualifying medical expenses.

To discuss how health savings accounts can factor into your financial plan we can schedule a call or zoom meeting to discuss Click Here

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Real estate has long been know as an investment vehicle that can produce income for its owners in a more tax efficient way than other investment options.  There are several different tax strategies that are involved with real estate investing and today we will examine the topic of depreciation. Through the proper use of depreciation the taxpayer can eliminate or reduce the income they are receiving from the property they own.  Here is an overview of depreciation and how it works.

What can be depreciated?

Property may be depreciated if is meets the following criteria:

1. The tax payer owns the property
2. The taxpayer uses the property in business or income-producing activity(e.g., rental property)
3. The property has a determinable useful life
4. The taxpayer expects the property to last more than one year

A taxpayer cannot depreciate personal-use property. The depreciation deduction is allowed only on the part of the property that is used for a burins or income producing activity.  In particular in this article I will focus on the depreciation of residential rental property.  In this case a taxpayer must use a straight-line depreciation method meaning they must deduct an equal amount each year throughout the property’s recovery period.  In the case of residential rental property the recovery period is 27.5 years.

How Depreciation Works

As we determined above, straight-line depreciation must be used for residential rental property and used over a 27.5 years.

Here is a quick example from The Balance Small Business:

Using an investment fourplex as an example, begin with a purchase price of $325,000. Assume the property will generate $15,192 a year in positive cash flow if all four units are rented out full time.

Now you can offset some of that income for tax purposes. You can depreciate the building by deducting out the value of the land and dividing the remainder, the building value, by 27.5 years to reach a figure for annual depreciation.

The depreciation calculation would look like this:

1. Purchase price less land value equals building value
2. Building value divided by 27.5 equals your annual allowable depreciation deduction

Assume that the value of the half-acre of land on which the fourplex sits is $80,000. The calculation would look like this:

1. $325,000 less $80,000 equals $245,000 building value
2. $245,000 divided by 27.5 years equals $8,909 a year in depreciation

Without taking any other property tax or mortgage interest deductions into account, you’ve already reduced your taxable rental income by $8,909 annually. And you didn’t have to spend any additional money to realize this deduction.

The benefit is that the depreciation amount is used to directly offset any income that you have from the property. If this amount results in a loss this loss can be used to offset other passive income gains.  Keep in mind that when/if you sell the investment property there may be a depreciation recapture that would get added to your gain amount and may be taxable to you.  Depreciation does not lower the income that you physically can receive, however, in the eyes of the IRS it does reduce your taxable gain on investments.  This is a great benefit for real estate investors.  

To discuss how real estate investing can factor into your financial plan we can schedule a call or zoom meeting to discuss Click Here

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On Wednesday, 4 of the most powerful CEO’s in the tech industry spent five and a half hours testifying in front of Congress. CEO’s from Google, Apple, Facebook and Amazon were questioned by Congress.  The reason they were called before Congress is to address accusations that these four companies are stifling innovation and crushing their competitors before they even have a chance to compete.  The chairman of the anti trust panel, Rep. David N. Cicilline (D-R.I.) accused these companies of creating monopolies in their industries and drew comparison to John D. Rockefeller and Andrew Carnegie.  They called out the CEO’s for acquisitions they have made throughout the years to eliminate competitors. This may not be the end of these hearings for the tech companies as they may be called back to testify again on a future date. 

With this backdrop the big tech companies reported earnings Thursday after the market close.  The earnings reports for Apple, Amazon and Facebook smashed estimates and each stock in premarket trading are up 5% or more.  The success of Amazon was strongly on display last quarter as the company grew both sales and profit. The 5 largest tech stocks now make up around 25% of the S&P 500.  This is why many analysts refer to the market as being heavily concentrated with big tech carrying the overall market.  Here is a chart of how these stocks have performed against that benchmark since last year.

After the bell today, Amazon beat the top line expectations by $8 billion, and Apple reported its highest third quarter revenue ever, growing 11% y/o/y. The fundamentals are justifying their massive growth.

Apple Stock Split

During the earnings call the board of directors at Apple approved a 4-1 stock split.  That means that for every share of Apple stock that an investor owns they will receive 3 more additional shares.  The stock price before the market open is trading above $400 that means that the new price of the stock will trade around $100.  Share holders can expect to see these changes in their account on August 31st.

To discuss what this could mean for your portfolio or a review of your investments Click Here

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Emergency Fund:

The volatility in the stock market, job layoffs and furloughs, unexpected expenses. This year has led to a lot of uncertainty for many Americans.  This has also shown us the need to have some cash set aside in case we have future emergencies. An emergency fund is a readily available liquid source of assets that can be used during times of financial distress.  Liquidity refers to how quickly you can convert those assets to cash that can be easily used for those unexpected expenses. Having money set aside to handle life’s curveballs are essential for your finances and to keep you out of missteps that could have long term ramifications.  The times when an emergency fund are found useful are: loss of a job, home or auto repair, medical emergency or an unexpected worldwide pandemic such as the Coronavirus(sounds crazy). 

Where can you put the money?

The most common place to put your money for use in case of an emergency is a checking or savings account. You want to make sure that whatever account you are using is separate from your everyday operating account. Also, this account should have a layer of difficulty that makes it not easily accessible.  Remember, a new pair of shoes or a flat screen tv that is on sale is not an emergency.

There is now a plethora of online banks that offer compelling benefits for placing the money with them. Traditionally, these banks are not as well-known and tend to pay a higher interest rate to earn your business. These accounts are known as high yielding, however, with the interest rate environment the way it is today these banks have had to cut their interest rates which have made them less appealing. The second item to look for when selecting a bank to hold your emergency fund is the impact of any fees. Most banks will charge a monthly fee if your balance is below a certain amount or if you do not have direct deposit setup on your account.  Be aware and make sure to select a bank that will not nickel and dime your emergency savings. Nerdwallet put together a list of good places to look that may have higher than average interest rates, the list can be found here.

Make sure that the money in your emergency fund is not invested.  This money needs to be easily accessible and available to be withdrawn the same day you need it.  Stocks, mutual funds and ETF’s should be avoided because of their appetite for risk and fluctuations that occur due to the market.  Also, CD’s are one of the last places you would want to place emergency fund assets because of the fee for early maturity.  Make sure that your money is in cash or a money market when you are building and sustaining your emergency fund.  Let me know if you would like some information on cash equivalents and the rates they are currently paying.

How much should someone have saved?

This question is different for everyone and there is no one size fits all solution. The typical rule of thumb that you may hear from Dave Ramsey is 3-6 months living expenses saved in cash. Dave also suggests that if you have bad debt, such as credit cards, that you have a beginner emergency fund will $1,000 saved. Most people have a “sleep well at night” amount that they like to see if cash and for the most part that could be used to cover an emergency.  Here are some factors to consider when deterining what about you need to have set aside in an emergency fund. Are you a one income or two income household, obviously a 1 income household will need to have more saved in the case of an emergency.  How quickly can you find a job? This is something that few can truly answer but there is an easy way to gauge this.  Ask people in your network or look around on LinkedIn to see if you are marketable and if finding another job would take little time.  One strategy you could use is however many months it will take to find a job, that is the corresponding amount you would need to have monthly expenses saved in an account.  Medical history, age of household appliances and state of your current automobile are all things to consider when determining how much to have saved in an emergency fund.  When dealing with an emergency your spending should only be on essential items.  Therefore, take time to examine your budget and see what expenses you can get rid of in times of a crisis.

Here are 4 quick ways to earn some cash to start building up an emergency fund.   

            For retirees and preretirees an emergency fund is different than the money you will have set aside for living expenses.  Although the money you have set aside will be in conservative investments or cash this is not to be used as emergency funds.  The money in your portfolio that you are conservatively investing is designed to cover ordinary living expenses, with that in mind you will still need to keep cash set aside in case of an emergency that can bring on unexpected bills. 

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The recent rally over the past two months has been something that has a lot of investors scratching their heads. Even with the tsunami of bad news, April and May were the two best consecutive months for the stock market since 1987.  The market is forward looking, therefore,  trying to time the market or waiting for “things to blow over” before putting money back into stocks oftentimes causes investors to miss the best days or months in the stock market.  So how has the market performed in May and for this year so far, take a look at this chart.

The recovery of the overall market has been led by the tech stocks holding their value and even increasing by over 9%, as shown by the return of the Nasdaq 100.  However, by looking at the S&P 500 Value index, those stocks are still down over 14% Year to Date.  We have seen a resurgence in value stocks in the trading days this week.  This is mainly caused by the reopening of the economy and many believe the rally in these stocks still has room to grow.  The value companies are heavily reliant on a growing economy and I believe we will start to see growth again by this fall.  This year financial stocks are still down double digits Year to Date, the low interest rate environment has hurt these companies, but as the economy reopens the financial sector could once again return to levels we saw earlier this year.  Adding an increase allocation to these value stocks and also small cap U.S. stocks is a good tactical shift to make over the next couple of months.  As the U.S. economic picture improves, adding exposure to small caps as well could lead to significant upside over the upcoming months.  Making these tactical rebalances to your portfolio can help to increase your chances that you are selling high and buying low.

As you can see from the chart above small cap stocks are still down sharply on a year to date basis. These companies have been hit hardest by the shutdown in the U.S. economy. Making a tactical shift to these sectors can help to boost returns over this next quarter. Historically small cap stocks have lead the market coming out of a bull market. We have not seen the surge in prices thus far but that could change over the coming months.  These stocks are still well below their 10 year annualized average return.

This rebound in stock prices has made investors feel uneasy and the recency the decline in stocks has many believing stocks will drop right back down to those levels. However, the rally that we have seen in stocks is normal coming out of a bear market. By looking at the chart below, the 1 year average return after a 20% drop in the market is over 41%.  3 years out from a 20% drop on average leads to an average annual return of 16%.   

What about bonds?

2020 has been one of the top performing years for bond investors.  This chart shows the return of bonds so far this year and as you can see they are up 5%. This is the importance of keeping a diversified portfolio. The shifts I will be making for my clients over the next couple of months will be into longer duration treasury bonds and short duration investment grade credit.

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