Amat Victoria Curam

Financial Planning Information for Military Professionals

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Increase Investment Returns by 3%…Interested?

MarketIf you could potentially increase the return on your investments, would you be interested?  A White Paper recently published by Vanguard postulates that a Financial Advisor can add up to 3% to your portfolio’s return.  This is significant as Vanguard has always been a champion of the Do It Yourself investor.  But, Vanguard remains true to its roots and doesn’t imply that Advisors can pick investments with any great ability.  Vanguard predicts the increase based on things you may not have thought of.  Here are the amounts and areas where Advisors can increase your return

  • Behavior Control, up to 1.50%.  Keeping your eyes on the long-term horizon and off the daily financial news
  • Asset Location, 0% to 0.75%.  Putting your assets in the correct accounts…tax advantaged or taxable
  • Using Cost-Effective Investments, up to 0.45%.  Keeping costs low can increase your return
  • Rebalancing, up to 0.35%.  As investments grow (and decline) your allocation will morph.  An advisor ensures that you stay in your target band.
  • Spending Strategy, up to 0.70%.  Selecting the right assets and the right accounts while drawing down assets is an important value add.

Is Vanguard right?  I don’t know.  They have the research to back it up (read the white paper here).  I do know that these areas are areas that I focus on when we “Control the things we can Control” (something my clients have heard me say many times).

What do you think.  Is Vanguard right?

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Your Rental and Your Taxes

HomeA lot of us end up with Rental Real Estate throughout our career.  It is the natural result of numerous PCS moves.  There are a lot of tax considerations when it comes to rental real estate.  So…since it is tax season I thought I would cover some of them.

Renting the Property.  Once you turn a piece of real estate into a rental a bunch of tax “benefits” become available.  Some of the major ones are:

Expense Deductions.  You can deduct any expenses you incur for the production of income at the property.  Normal expenses include:  Repairs, Maintenance and Cleaning, Advertising, Management Fees, Mortgage Interest and Commissions.  These expenses can be used to offset income in the year they occur (normally).

Depreciation Deductions.  Normally things wear out.  The IRS allows you to account for this through depreciation.  You depreciate the structure (house) over 27.5 years.  So each year, you’ll be able to deduct just under 4% of the value of the structure(s).  A couple of notes.  First, depreciation is not really optional.  You must depreciate the property.  Second, the value used for the depreciation is the Fair Market Value of the property when purchased or placed in service as a rental…whichever is lower.  If you make improvements to the structure, such as a new roof, you do not expense them in the year acquired, but rather depreciate the improvements over the life of the improvement (could be less than 27.5 years).

Taking Deductions on Your Taxes.  You may be able to deduct up to $25,000 in losses on your rental property against your other current income.  To do this, you must Actively Participate in the management of the property.  The IRS has specific criteria to determine if you actively participate.  If you don’t actively participate in the management then your losses are passive and can only be deducted against passive income.  If your Adjusted Gross Income exceeds $150,000 even if you actively participate in the management of the property you can’t take the deductions.  Any deductions that you can’t claim on your taxes in the current year roll forward until you sell the property.

Selling the property.  Just like when you rent the property there are tax issues, there are also tax issues when you sell it.

Depreciation Recapture.  When you depreciate a piece of property, you are in effect saying it is wearing out and not worth as much.  When you then turn around and sell it at more than what you said it was worth, the IRS says, “Wait a minute.”  If you sell your property at more than it’s adjusted basis (FMV + Improvements – Depreciation) then the IRS wants the depreciation back.  Any amount from the adjusted basis to the FMV when placed in service is what is called 1250 gains.  1250 gains are normally taxed at 25%.  You can’t avoid depreciation recapture by refusing to depreciate the property.  1250 gains are due on the deprecation taken or that should have been taken.

Capital Gains.  If you sell the property for more than its FMV when placed on the market you will owe capital gains taxes.  Depending on how long you owned the property the gains will be either short-term or long-term.  The gains will be taxed at your appropriate capital gains tax rate.  If the property was worth less than its purchase price when placed in service, sales between the FMV and the original purchase price are generally not considered gains (this could apply if you lived in the house before it became a rental).

Primary Residence Exclusion.  If the house still qualifies as a primary residence (you lived in it for 2 of the last 5 years …or up to 15 years if still on active duty), you will not have to pay taxes on the capital gains.  You will however have to pay taxes on the Depreciation Recapture.

1031 Exchange.  If you exchange the rental property for another rental property you can avoid current taxation.  1031 exchanges are a little complicated and you will need to hire a trustee to hold the money, if you sell the house.  But, they can be done.

Real Estate is one of the last great tax shelters.  Even if you can’t deduct current losses, you can shelter income from taxation…which can be a great benefit.  While direct ownership of real estate is not for everyone if you do decide to own real estate or if you are forced to by a PCS, you want to make sure you understand the tax implications…or get help from someone who does.

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What the Russians (re) Taught Me Yesterday

MarketIf you’re watching the news, you know that Russia moved forces into the Crimea region of Ukraine yesterday (Monday, 3 Mar 14).  Now, I generally don’t recommend that you should check your investments daily, but if you did yesterday you probably heard a lot of news about how “bad” the “market” did.  But did it really?

Well, the following are some of the investments that did poorly yesterday…

  • The S&P 500 was down
  • Most European stock indexes were down
  • Asian stock indexes didn’t do much better either

But, on the other hand…

  • Gold was up (around 2%)
  • US Treasuries were up
  • The dollar was up versus other currencies
  • Real Estate (as indicated by REITs) was generally up

So what is the point?  First off, don’t look at daily gyrations of the “market”.  Remember, the financial presses are in the business of selling advertising…not sound advice.  And if you just can’t help yourself remember that if you portfolio is properly diversified, then you may have some winners to go along with your losers and it probably isn’t as bad as the news would make you think.  Just a reminder though…there is no guarantee that a diversified portfolio will prevent loss.

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Maximize Your Social Security Benefits

Almost 80% of Americans take their Social Security Benefits early.  Why?  I don’t know for sure, but I bet most of them don’t put much thought into it.  Let me put it this way…If I offered you a Savings Account that paid 7.43% interest with no risk would you want it?  That is essentially what Social Security pays, but yet many Americans take their benefits early.  Here are some other concepts you might want to understand before you take Social Security.

Delaying Benefits.  As demonstrated above, if you wait to take your benefits you earn interest.  Technically, Social Security increases 8% for each year of delay (It doesn’t compound so it is closer to a 7.43% compound rate) after your early retirement age (currently age 62) until you reach age 70.  This is especially important to consider for surviving spouse benefits.  Remember, the surviving spouse will earn the highest of the surviving spouse’s earned benefits or the deceased spouse’s earned benefits.

File and Suspend.  You can file and suspend your benefits.  When you file and suspend you activate your benefits and then stop the payment.  This can be helpful in two scenarios.

  • Concerns About Losing Benefits.  Many individuals take their benefits early because they are concerned that they may not live long enough to get their money back.  If you file and suspend you can change your mind and get back pay.  So, if you become ill and it becomes obvious that you’re not going to make it that long or if you have big bills you can get the benefits you suspended paid in a lump sum.  If you don’t need the benefits you can reinstate the benefits at the higher amount.
  • Starting Spousal Benefits.  You can file and simultaneously your spouse claims spousal benefits.  Then the older/wage earner spouse suspends.  The result of this is that the spousal benefits are paid immediately and the wage earners benefits continue to grow in value until age 70.

One word of warning, if you file and suspend make sure you make arrangements to pay your Medicare premiums so that you maintain your access to TRICARE For Life.

Working at Different Ages.  If you start taking Social Security Benefits before Full Retirement Age (66 or 67 for most of us) you will lose benefits if you earn too much money ($15,480 in 2014).  In the year you reach Full Retirement Age, the reduction will be less.  If, on the other hand, you work after age 70 you can still increase the value of your benefits by increasing the earnings on which your benefits are calculated.

Social Security Benefits Taxation.  Benefits for most readers of this blog will be taxable.  However, careful tax planning in regards to investments can reduce taxable income to a point where the benefits won’t be taxable.  This may be applicable for your parents or if you decided to not take SBP.

There are a lot of variations and the combinations get even more complicated if both spouses have earned benefits.  This is something I spend a lot of time studying and working on for my clients.  Take the time to understand all the ramifications of your decision or get competent advice.

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Claiming the Kids

Tax CalendarI think a lot of people get confused on whether they can claim their children as dependents.  Many lose deductions because they don’t understand that even if the kids are “grown” they may possibly qualify as a dependent.  In fact, there are two different ways a child can become a dependent for Federal Income Tax purposes.

First off, a dependent can be a Qualifying Child.  To be a Qualifying Child, the following criteria must be met.

  1. The individual must be the taxpayer’s son, daughter, stepchild, foster child, brother, sister, half brother, half sister, stepbrother, stepsister or a descendant of any of them.
  2. The individual must be:
    • Under age 19 at the end of the year and younger than the taxpayer (or the taxpayer’s spouse, if filing jointly)
    • Under age 24 at the end of the year, a full-time student, and younger than the taxpayer (or the taxpayer’s spouse, if filing jointly), or
    • any age if permanently and totally disabled.
  3. The individual must have lived with the taxpayer for more than half of the year.
  4. The individual must not have provided more than half or his or her own support for the year
  5. The individual must not file a joint return for the year (unless that return is filed only as a claim for refund)

A Child can also qualify as a dependent if he or she is a Qualifying Relative.  To be a qualified relative, the individual must pass four tests.

  1. The person cannot be the taxpayer’s qualifying child or the qualifying child of any other taxpayer (so in most cases we’re talking about a child older than one of the age limits above).
  2. The person must either
    • Be related to the taxpayer in one of the ways listed below
    • Live with the taxpayer all year as a member of the taxpayer’s household (and the relationship must not violate local law)
  3. The person’s gross income for the year must be less than $3,900 (for 2013) or $3,950 (for 2014)
  4. The taxpayer must provide more than half of the person’s total support for the year

The following individuals meet the related-to-the-taxpayer requirement

  1. The taxpayer’s child (including an adopted child), stepchild, foster child, or a descendant of an of them (for example, a grandchild)
  2. The taxpayer’s brother, sister, half brother, half sister, stepbrother or stepsister
  3. The taxpayer’s father, mother, grandparent, or other direct ancestor, but not foster parent
  4. The taxpayer’s stepfather or stepmother
  5. The son or daughter of the taxpayer’s brother or sister
  6. The brother or sister of the taxpayer’s mother or father; or
  7. The taxpayer’s son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law

Now, there are some other rules that apply to what “living” with the taxpayer actually means and some other variations.

The economy is tough and a lot of Senior Military Officers welcome their kids back into the house as they conduct an extended job search.  And, a lot of us make assumptions about tax law and lose deductions to which we are entitled.

The bottom line is the tax law is complicated and your computer program might not know to ask you the right questions.

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Beware the Bermuda…I mean Insurance…Triangle!

BermudaThe Bermuda Triangle is a pretty scary place, or so I’ve heard.  Something equally scary involves the Insurance Triangle.  Are you scared yet?

The Insurance Triangle results from the fact there are 3 different “parties” to a life insurance policy.  Let’s start out with who those parties are (one person can be more than one party).

  • Insured.  This is the party on which the policy is written.  In other words, when this person dies, the policy pays.
  • Owner.  Normally this is the party who pays the premiums and designates who will be paid when the insured dies
  • Beneficiary.  This is the party that gets paid when the insured dies

Life Insurance can be an effective estate planning tool and can even be an income tax sheltered or income tax free investment choice.  This is because Life Insurance proceeds pass to the beneficiary free from income tax.  But Life Insurance proceeds can be subject to estate taxation if the owner and the insured are the same person.

So, one way to avoid the estate tax problem is to make the owner and the beneficiary the same person.  Just in case you were wondering, anyone can own an insurance policy on anyone in which they have an insurable interest.  So, for example a divorced spouse who relies on alimony for living expenses could own a life insurance policy on the ex-spouse.  The bottom line is that if the owner of the policy and the beneficiary are the same person, the life insurance proceeds are free of estate and income tax.  But people try to get even more creative…

Enter the Insurance Triangle.  An Insurance Triangle exists when the three parties above are three different people (or entities).  When would this happen?  There are a lot of different scenarios.  I received a question the other day with this scenario.

  • Divorced Parent
  • Wanted to own policy on ex-spouse
  • Didn’t want proceeds of the policy so wanted to name children (minors) as beneficiaries of the contract

Or here is another

  • Parent with two adult children
  • Wanted to name both children as beneficiaries on policy on parent’s life and did not want proceeds in parent’s estate
  • Younger child is special needs, so named older child as the policy owner (parent paid premiums)

In both cases above, when the insured dies, there will be a gift in the amount of the insurance proceeds, that could be taxable, to the one or more beneficiary (since they didn’t own the policy).  In scenario 1 above, all the children will receive a gift (potentially subject to tax).  In scenario 2, the special needs child would receive a gift, again potentially subject to gift taxes.  Whether the proceeds will be subject to gift tax will depend on the size of the policy, previous gifts from the parent subject to taxation and the tax law in effect at the time of death (not that tax laws ever change).   Also, in scenario 2, the premiums could be subject to gift tax if they exceed the annual exclusion

You can avoid the triangle and accomplish the desires expressed in the two scenarios with effective estate planning and the use of insurance trusts.  But, like many Senior Military Officers and NCOs have heard me say at ETAPs, don’t do estate planning without a net.  Get advice from a competent financial planner or estate planning attorney.

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MyRA…We’ll See

CapitalThe President announced a new retirement savings account last night in his State of the Union Address.  I doubt it will have much of an impact on Military Members, especially Senior Military Officers.  But here is what I know so far…

  • MyRAs will be offered through employers
  • Apparently the only investment option allowed will be or be very similar to the TSP G Fund
  • While there are advantages to the G Fund, as a single asset in a retirement portfolio it has its limits
    • In 2013 the G Fund returned 1.89% and Inflation was 1.5% (as measured by CPI)
    • So, an investor in the G Fund only, beat inflation by 0.39%
  • In a balanced portfolio it could have a place as a replacement for “Cash”

From what I understand the Treasury Department will roll out the program today.

I’ll keep my eye on this and let you know what I find out.


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