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Tag: Taxes

Control and Influence

As the father to four young men, one of my goals is to successfully make the transition from a relationship of control to one of influence. Control is easy, right?  Do this, don’t do that. For example, don’t take off your clothes and turn the garden hose on the sweet little Japanese family that your mom tutors.  In my defense, I didn’t think I would have to provide such counsel to my 4-year-old, but I guess I should have. First-time parent rookie mistake, I guess.  Or please do take off your clothes before using the restroom. Thought I covered that in the first several years or so, but I guess not. (Sophomore slump with #2 – child #2, that is.)  And one of my personal favorites of #2, please don’t tell the hairy man at the pool that you thought cavemen were extinct. On second thought, maybe control isn’t that easy. But in the world of personal finance, believe it or not, control is a bit more obtainable.

Today and every day, and in every facet of our lives, we should be focusing more on things we can control and worrying less about the things we can’t. In the world of finance, for example, none of us has any control over the markets, taxes, interest rates, inflation or the headlines of tomorrow’s news outlets. Yet, such things can affect our outlook on our financial situation and lead us down the path of worry and anxiety. And left unchecked, that worry can lead to paralyzing fear, or possibly worse, emotionally charged decisions. Both of which can be detrimental to our financial wellbeing. So, what should we focus on?  There are essentially four primary factors within your control when it comes to your finances. I’ll present these in a “self-fulfilling prophesy” kind of way.

I can control how much I spend.  Unless you have an unlimited supply of resources, your spending will need to be controlled. Similar to exercise, it can be difficult and painful, but it can be done. And you’ll be better off because of it. Let’s define spending as how much you’re choosing to live on every day and how much you’re choosing to spend to enjoy your life today and in the years to come.

I can control how much I save.  I will save X amount now, so that I’ll have Y amount to spend later. If you’re still in the wealth accumulation stage, you or your spouse likely have access to a 401(k) retirement savings plan. And in some cases, your employer may incentivize you to save for retirement by offering an employer “match.” That is, your employer will match a certain percentage of your contribution (to your plan) up to a certain percentage of your salary. In such a case, your decision to save not only provides for your contribution to be spent later, but your employer matching contribution as well.  The industry term there is “free money”. And yet another contributor to your retirement account will be the law of compounding returns – what Einstein called the 8th wonder of the world – whereby you’re earning returns on both your original investment and on returns you received previously. Picture a snowball rolling down a mountain, picking up more snow as it goes. Before long, your snowball is a heaping mound of cash. You catch my drift.  See what I did there? (Bonus Track:  Look up the Rule of 72 and thank me later.)

I control how much risk I take. Indeed, you do. Not every person that invests in the stock market is 100% invested in stocks.  In fact, an August of 2024 survey from Empower Retirement has the average stock allocation for those in their 20s, 30s and 40s to be approximately 50% of their total portfolio. Can you guess which age group from that same survey is credited with holding the 2nd highest percentage of cash at a whopping 30.8%?  Wrong – those in their 20s. Bested only by retirees 70 and older.1 A post for another day, maybe, but such a conservative and seemingly “risk-averse” strategy may be anything but.

I control the timing of my financial decisions. Yes, you do. Like when you pull the trigger on a large purchase, or decide to retire, change jobs or (these days) even take on a second job. Also within your control is the timing of when to save more, spend less, invest more aggressively. They say, Timing is everything. I don’t know about everything, but it’s a fairly big lever to pull with respect to your financial security.

As I’m sure you’ve recognized by now, these four areas of control are inextricably linked.   You’d be hard pressed to change one without affecting the other. Again, assuming resources are finite, if you choose to spend more, then you’ve also chosen to save less. If you’re spending less, you very well could be saving more. And saving more (or saving less) will certainly subject your goals to more (or less) risk, right? If, for example, you’re spending a great deal of money now on Alabama season tickets, you’ll presumably have less money saved to put your daughter through Auburn. (We’ll do anything for our kids, won’t we?) And anytime you’ve chosen to make any changes in savings, spending or risk taken – or not – you’ve made a decision in timing.

So where does influence come in? Great question. Influence certainly has its role in your finances. As we’ve stated, none of us will likely ever move the stock market, nor will we affect the tax structure or control interest rates.

Each of those, however, will influence what we can control.

Let’s say inflation rises – a lot. And you find yourself barely having the money for the things you need – much less the things you want. Now what? Well, that means you’ll need to prioritize and spend less on the things you could do without and save more for the things you really want. Or possibly change the amount of risk you’re taking to increase the chance you’ll make more money for the things you want. Maybe you’ll choose to work longer? Or maybe you’ll have to find a new job or possibly a second one?  Or it could easily be some combination of these. It’s important that we understand when it’s time to adjust the factors that are within our control – our spending, our saving, the risk we take, and the timing of our decisions. Many factors can and will influence our decision-making process. Which begs the question,

Do you know what matters most to you in your financial life?

A quick answer can be found in your check register. Or for those of you under the age of 50, your online bank statements.  Your answer to that question will guide you as you create a plan to help you live your one best financial life. And through that financial plan, you’ll be able to manipulate those areas within your control in anticipation of those influencing forces outside of it.

As for my boys, #1 is married and finishing up med school, #2 is a junior at Auburn and literally creating his own path toward a career of film/sharks/ecotourism, #3 is a senior in high school and likely to change the world through music, and #4 is a sophomore in high school and winning the hearts of college basketball and soccer coaches alike. All accomplished young men in their own rights, but all benefiting from the influence of those who’ve gone before them. I’m honored to be a part of that counsel.  Whether serving as a father or a financial advisor, having influence for the betterment of one’s life is a legacy I’m proud to be a part of.

Article by:  Billy McCarthy, Investment Advisor

To discuss this article further or to learn more about CapSouth Wealth Management, visit our website at www.capsouthwm.com or www.capsouthwm.com/what-we-do/ Call 800.929.1001 to schedule an appointment to speak with an advisor.

1  What is the average allocation by age? (Empower Retirement, The Currency, 08.07.24)

 

Investment advisory services are offered through CapSouth Partners, Inc, dba CapSouth Wealth Management, an independent registered Investment Advisory firm. Information provided by sources deemed to be reliable. CapSouth does not guarantee the accuracy or completeness of the information. CapSouth does not offer tax, accounting, or legal advice. Consult your tax or legal advisors for all issues that may have tax or legal consequences. This information has been prepared solely for informational purposes, is general in nature and is not intended as specific advice. Any performance data quoted represents past performance; past performance is no guarantee of future results.

 

 

 

Underestimated Tax Payments

One of the items that I look at when I review an income tax return for our clients is whether the taxpayer was assessed an underpayment penalty. I have discovered that a lot of clients are not aware of how much these rates have increased and what they can do to reduce the penalty. Hopefully, the following will be helpful to you if you are subject to paying estimated income tax penalties.

 

First and foremost, remember that the payment of income taxes is a concept of “pay as you go” method. This refers to the system where taxpayers are required to pay their income taxes throughout the year as they earn income, rather than paying the entire amount owed at the end of the tax year.

 

The Internal Revenue Service imposes penalties for underpaying estimated income taxes throughout the year. These penalties, known as the “estimated tax penalty” or “underpayment penalty,” are calculated separately for each quarter based on the amount of unpaid tax for that period.

 

How the Penalty is Calculated:

The penalty equals the federal short-term interest rate (in the first month of the quarter in which taxes were not paid) plus 3 percent. As of mid-2024, the estimated tax penalty has reached a whopping 8% – the highest it has been since 2007. This penalty is not deductible, so the effective rate is even higher.

 

Avoiding the Penalty:

To avoid the underpayment penalty, individuals with an adjusted gross income (AGI) of $150,000 or less must pay by the due date of the tax return the lesser of:

  1. 90% of the current year’s tax liability (paid through withholdings or timely quarterly estimates)
  2. 100% of the previous year’s tax liability

 

For those with an AGI above $150,000, the threshold is higher at 110% of the previous year’s tax liability. These amounts can be paid through a combination of withholding from paychecks and timely quarterly estimated tax payments.

 

It’s important to note that meeting the safe harbor requirement (either 100% or 110% of the previous year’s tax liability) guarantees avoidance of underpayment penalties, regardless of your actual tax liability for the current year. However, if you expect your income to decrease, you may choose to pay 90% of your estimated current year tax liability instead, though this carries more risk of penalties if your estimate is too low

 

Safe Harbor Rules

The IRS provides “safe harbor” rules that allow taxpayers to avoid the penalty if certain conditions are met, such as:

  • Owing less than $1,000 in taxes (This is not after estimated or withheld taxes, it is the total tax owed)
  • Paying at least 90% of the current year’s tax liability through withholdings and timely estimated payments

 

Notice that taxes withheld from wages & other sources are treated as if they were withheld equally over the year.

    • Withholding a large amount from an IRA distribution towards the end of the year does gives you credit for tax payments as if you made them equally throughout the year.
    • When you take a taxable distribution from your traditional IRA, you have the option to have federal income tax withheld from the distribution amount. The default withholding rate is 10%, but you can elect to have a different percentage withheld using IRS Form W-4R. The withheld amount is credited against your total tax liability when you file your tax return for that year.
    • However, the timing of the withholding does not affect how the payment is credited. Whether you withhold the entire amount in December or spread it out evenly throughout the year, the total withheld will be treated the same way – as a prepayment towards your tax liability for that year. There is no advantage or credit given for making withholding payments earlier in the year.
    • The IRS does not consider when the withholding occurred – only the total amount withheld for the tax year. If too little tax is withheld compared to your actual tax liability, you may owe additional taxes plus potential underpayment penalties when you file your return.
    • So in summary, while withholding from an IRA distribution can help cover your tax liability, the timing of when that withholding occurs within the tax year is irrelevant. The total amount withheld is simply credited as a prepayment when you file, regardless of whether it was withheld upfront or at the last minute

 

 

Quarterly Payment Deadlines

For those required to make estimated tax payments (e.g., self-employed individuals, business owners), the quarterly deadlines are typically:

  • April 15
  • June 15
  • September 15
  • January 15

 

However, these dates may be adjusted if they fall on a weekend or holiday. By understanding the estimated tax penalty rules and making timely payments through withholding or estimated payments, taxpayers can minimize or eliminate this costly penalty.

 

One effective way to minimize or avoid the estimated tax penalty is to use the annualized income installment method. This method allows you to pay estimated taxes based on your actual income earned during each period of the year, rather than having to project your entire year’s income upfront.

 

The annualized income installment method divides the tax year into four payment periods, with each period using a different income annualization factor:

  1. Period 1 (Jan 1 – Mar 31): Annualize income for this period by multiplying by 4
  2. Period 2 (Jan 1 – May 31): Annualize by multiplying by 2.4
  3. Period 3 (Jan 1 – Aug 31): Annualize by multiplying by 1.5
  4. Period 4 (Jan 1 – Dec 31): No annualization needed for full year

 

By annualizing your income for each period based on the actual amounts earned, you can make more accurate estimated tax payments that reflect your cash flow. This reduces the likelihood of underpaying and being subject to penalties.

 

To use this method, you need to complete IRS Form 2210 (Underpayment of Estimated Tax by Individuals) and attach it to your tax return. Be sure to check Box C for “Annualized Income Installment Method” under Part I.

 

While the annualized method involves more calculations, it provides flexibility for those with fluctuating or seasonal incomes. It ensures you pay the proper estimated taxes based on what you’ve actually earned, rather than an upfront projection.

 

So, if your income varies significantly throughout the year, strongly consider using the annualized income installment method. It can save you from costly underpayment penalties by aligning your estimated tax payments with your actual earnings pattern.

 

If you have your tax return prepared by a tax practitioner, be sure to provide them with the information that they will need to use this method. They can determine the amounts from the sale of assets where they have the dates sold. However, for income that you receive a 1099 for, you will have to provide the dates received to them.

Article by:  Lewis Robinson, CPA

To further discuss this article, contact Lewis Robinson at LRobinson@capsouthpartners.com

To learn more about CapSouth and the services we provide, visit our website at capsouthwm.com/what-we-do/ or click here to schedule a Discovery Call.

Investment advisory services offered through CapSouth Partners, Inc., dba CapSouth Wealth Management, an independent Registered Investment Advisor. This material has been prepared for planning purposes only and is not intended as specific tax or legal advice. CapSouth Partners does not provide tax or legal advice. Please consult your tax or legal advisor prior to making decisions which may have tax or legal consequences. Information provided by sources deemed to be reliable.  CapSouth does not guarantee the accuracy or completeness of the information.

 

Retirement Planning: Before and After

Working with clients, I often find that retirement planning can be an ambiguous idea for many, with numerous factors and circumstances to consider, when many of us are just trying to get through the next year…or even the next week!  We plan for retirement because we know that we likely do not want to have to work forever, and we know that there are steps we should be taking now when time is on our side to ready ourselves for that freedom of “making work optional”. 

Once clients reach retirement, there is still often a significant change of thought process.  I often get questions from clients… “What do we do now?  How do we convert our accumulated assets into monthly spendable income? 

With your input, we endeavor to devise a plan that puts you on the road to financial security.  The result is designed to leave you with sufficient assets so you can maintain your desired lifestyle or pursue new interests that you may develop in retirement.

We can help you with the numbers.  But first, let’s ask some basic open-ended questions.

  • What are your values?
  • How do you feel about money?
  • What goals do you have for retirement?
  • When would you like to retire?  Full retirement or change of employment with reduced income for a time?
  • What would you like to do in retirement?
  • How would you spend your days?
  • Do you enjoy traveling?
  • What are your hobbies?
  • Do you want to stay in your home or are you considering a smaller place?
  • Would you like to live in a different location?
  • Would you move closer to family or kids?
  • Or would you choose a location based on climate or quality of life?

Your goals are your goals.  They are not mine.  They are not your family members’ goals, and they are not your friends’ goals.  Your personal values and goals play a big role in your retirement planning picture.

BEFORE RETIREMENT (Already retired?  You can skip ahead or read anyway and tell your friends!)

Retirement sounds great, but can’t we balance those savings with enjoying today as well?  Yes, and we should!  Here are some general retirement planning guidelines:

  1. Set aside six months of expenses in an emergency fund. While skyrocketing interest rates have hampered stock market performance over the last year, savers can currently earn 5% or more risk-free. We’d be happy to point you in the right direction.
  2. Save up to 15% of your income in your company’s 401k. If zero to 15 in one paycheck leaves you short of breath, start small and ratchet it up over time.  You won’t miss the cash. But if it turns out that 15% is too difficult or interferes with other financial goals, at least always capture your company’s match.  It’s free money!  Why leave any behind?
  3. Build a “Life Account”. Make sure your savings are not solely in your retirement account.  “Life” will likely happen prior to you reaching age 59 ½.  Build a comfortable level of funds in a taxable investment account that you can access without tax penalties when needed prior to retirement age.
  4. Get out of debt. This includes student loans, credit cards, and auto debt.  We can talk about whether you should try to pay down your mortgage in a timelier manner…it depends.
  5. Max out IRA/Roth IRA and HSA. Consider fully funding an IRA or Roth IRA account and max out your health savings account if it’s offered as a part of your health coverage.
  6. Are you 50 or older? If so, consider catch-up contributions for retirement savings.  For an IRA, you may contribute up to $7,500 in tax year 2023. The 401(k) contribution limit for 2023 is $22,500 for employees.  If you’re 50 or older, you’re eligible for an additional $7,500 in catch-up contributions.
  7. Diversify within asset classes and among asset classes. When you are young, a diversified portfolio that leans heavily on the equity side of the allocation is probably your best choice.  Dollar-cost averaging through regular contributions allows you to take advantage of market dips. As you near retirement, you will likely want to gradually reduce risk by shifting to fixed income investments and reducing your exposure to stocks.
  8. Leave room for fun. It is certainly important to set goals and to make a plan to achieve those goals.  It is also important to live a little!  Saving everything and living on sardines alone is not fun for most of us.  Retirement planning allows us to put our savings into perspective and to know where we want to go and what it will take to get there.  Once we have that picture, we can evaluate the tradeoffs of saving more and retiring earlier or spending more in retirement, or retiring later and being able to spend more either now or in retirement.  I believe there can be freedom in a healthy balance between saving for the future and enjoying life now.  It really is all about a personal plan to challenge you to define and to live your One Best Financial Life®.

AFTER RETIREMENT

Our retirement planning work is not done just because we reached that long-awaited goal of retirement!  The direction of our work and our questions pivot to maximizing this period of your life. 

There are many factors that can derail your retirement picture – investment risk, inflation risk, catastrophic illness, long-term care, and taxes to name some.  A comprehensive retirement planning process should account for stress testing these obstacles to provide confidence in the probability of your success under these scenarios. 

Below are some general concepts to evaluate during this period of life:

  1. Think of retirement in phases. Our ability to enjoy our retirement years often wanes over time due to our health.  This is sometimes referred to as your go-go years, your slow-go years, and your no-go years.  You may decide that you want to continue to work part-time in the early years of retirement.  You may want a larger travel budget that reduces over time.
  2. Increase your reserve fund. While six months’ expenses may be an adequate emergency fund during working years, you may want to extend that to a year’s worth of expenses during retirement.  This comfort level is certainly different for each client, however the objective is to not have to liquidate funds in a down market.  This consideration will also factor into recommendations of investment allocations across various accounts or “buckets” of money.
  3. Systematize and Keep It Simple. We generally recommend evaluating your regular living expenses and your current income sources, and then setting up an automatic, once per month transfer from an investment account to your checking account for the difference.  For you, there is still a systematic income each month that resembles the paycheck you received prior to retirement.  Your overall investment allocation can be set up so that the account those transfers are coming from is invested with about a year’s worth of funds at a conservative risk level.  This account is then replenished periodically from other accounts based on market conditions and tax strategies.  The goal is for you to be able to enjoy life, and for us to manage that income flow for you.
  4. Consider Social Security carefully. Various timing strategies are available for claiming Social Security benefits.  Many times clients are eager to begin drawing their benefits as soon as they can – after all, they have been paying into them for years.  However, claiming early can have significant impacts on your total benefit.  Though you can begin drawing at age 62, you will receive a reduction of 5/9th of one percent for each month you draw earlier than your full retirement age (FRA) up to 36 months, and 5/12th of one percent for each month thereafter.  For example, drawing at age 62 when your FRA is age 67 will result in about a 30% reduction in your benefit. Delaying Social Security after your FRA has benefits worth considering.  You receive a guaranteed 8% increase for each year you defer your benefit from your FRA to your age 70.  This is in addition to any cost of living adjustment. For married couples, the timing of Social Security claiming is of particular importance for the spouse with the higher benefit amount.  After the death of the first spouse, the surviving spouse will get the higher of the two benefits.  The lower benefit amount will then cease. It is also of note that a divorced individual who was married to their previous spouse for more than ten years has the right to claim on the former spouse’s benefit without affecting the former spouse’s personal benefit. When should you file?  The answer will depend on your specific circumstances and the greater context of your financial plan, including the consideration of your health and family longevity.  A greater Social Security benefit is helpful if you or your spouse are alive to receive it.
  5. Don’t Forget Taxes. Tax planning is arguably more important than ever in retirement.  The timing and order of withdrawals from various types of accounts can have significant tax consequences – negative and positive. For clients with no concern over beneficiaries, maybe withdrawing from taxable accounts first, then tax-deferred, and finally tax-free accounts is best.  However, even in this example, consideration should be given to current and future tax rates and brackets, and the impact of Medicare IRMAA charges and Social Security taxation on a surviving spouse. Clients who expect to leave funds to their children or other heirs should add particular consideration to substantially appreciated assets that might be better held and passed at death to obtain the step-up in basis for the heirs. Roth conversions can be utilized to take advantage of lower income years or lower tax rates, moving assets from tax-deferred to tax-free growth going forward. Charitable goals can increase the benefit of sound charitable planning.  Utilization of batched giving, a donor advised fund, or maintaining tax deferred funds for future qualified charitable distributions after age 70 ½ are some valuable strategies that may apply.
  6. Remember that your plan knows about those dollars, too. Clients sometimes mention spending accumulated funds held in outside accounts on splurge purchases with a comment like, “But those were from my funds in my other account.”  Or, “those funds came from the sale of that investment property I had”.  It is very important to remember that your plan has likely accounted for those funds, too. 

When building a client’s plan, we discuss various resources including retirement accounts, pension incomes, rental property, private investments, etc.  Sometimes those income sources are for limited periods, or they might come in as a one-time future infusion of income.  Your plan factors these income sources in, as well as the growth on those assets once received, to fund your current and future retirement goals. 

Inflation can have a significant impact on your retirement expenses over time.  The longer a retirement period, the greater the impact.  By the time that the long-term care need occurs, the cost will likely be much greater than you might think.  The cost of your current lifestyle will likely cost substantially more twenty years from now.  Funding those future goals generally requires growth of your assets over time. 

It is easy to think of your current expenses and to get too comfortable with those being covered by part-time income, short-term or level pension amounts, etc.  It is important, though, to have a comprehensive retirement plan that keeps everything in perspective and to remember that your plan is counting on those excess funds received to be invested in accordance with long-term investment allocation.

There are no easy roads, but a disciplined approach to retirement planning that emphasizes consistent savings, a modest lifestyle based on your income, and minimal debt should serve you well as you travel the road toward financial security and retirement.  A sound financial plan also provides freedom.  Once you know you have your bases covered for retirement, you can feel more free to enjoy life now as well.

If you have questions about any of these concepts or how they might apply to your situation, please reach out to me or your CapSouth advisor.

To learn more about CapSouth Wealth Management visit our website at https://capsouthwm.com/what-we-do/or Connect With Us to learn more about our process.

By: Scott F. McDowall, CFP®

CapSouth Partners, Inc, dba CapSouth Wealth Management, is an independent registered Investment Advisory firm. This material is from an unaffiliated, third-party and is used by permission. Any opinions expressed in the material are those of the author and/or contributors to the material; they are not necessarily the opinions of CapSouth. Information provided by sources deemed to be reliable. CapSouth does not guarantee the accuracy or completeness of the information. CapSouth does not offer tax, accounting or legal advice. Consult your tax or legal advisors for all issues that may have tax or legal consequences. This information has been prepared solely for informational purposes, is general in nature and is not intended as specific advice. Any performance data quoted represents past performance; past performance is no guarantee of future results.

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