Client Newsletter 2Q21
Dear Ambassador Family,
Happy Spring! It’s time to talk about a subject most of us would rather avoid (but can’t):
Taxes!
“It’s not what you earn that matters, but it’s what you keep.”
You have heard me repeat this saying over the years. But I want you to take this to heart.
I’ll share a quick investment update, then we’ll talk about why taxes matter, what we are doing to help clients like you, and what steps you might consider to alleviate taxes.
Investment Update
It was only a year ago when we were talking about the big decline in the markets.
Since then, we have had an amazing roller coaster ride. COVID19 nearly shut down the economy. Then, the Fed intervened with massive amounts of money to keep things open and avert economic disaster. Multiple stimulus bills were passed. Cash was printed, and interest rates were slashed to nearly zero. The whole world was in the same boat.
The economy responded, as did your investments.
Since the start of 2021, the economy has started to reopen. With this, more shifts will occur. Headed into the year, we recognized opportunities in areas that could benefit from supply shortages. While a reopening economy is positive, challenges also accompany it: potential inflation, higher taxes, and a weaker dollar.
Inflation could be a problem for those seeking to preserve their standard of living. We have taken action across portfolios to preserve and grow purchasing power. This is especially critical for those of you who are living off your money. After many years of falling prices, however, the trend might be changing. Consequently, we have invested some of your money into areas that benefit from rising demand and limited supply
Some examples that might point to higher inflation include higher prices in commodities such as gas, food, and lumber, wage hikes for small businesses unable to hire lower-level employees, and the continued decline in the US Dollar versus other foreign currencies.
We currently see a balance of risks and opportunities in markets. While fundamentals are fairly robust and liquidity is more than ample, valuations are quite high and leave little room for negative event risk.
We are honored to serve you—and your family and friends. When your family and friends “join the Ambassador Family,” everyone can benefit.
How does it work?
Alone, small investors often get minimal service at a high fee.
However, when your friends and family come to us, we look at the size of your relationship as if you were one big happy family.
This includes your children or grandchildren, extended family, and even your close family friends.
You all benefit from the opportunity to get high-quality service at a discounted rate of the combined relationship.
Please feel free to invite other family members and friends to enjoy these benefits. We would love to talk with anyone who might need our help.
That’s what we call quality service at “friends and family” pricing.
Why Taxes Could Be a Growing Problem for You in 2021 (and Beyond)?
Okay, let’s talk taxes. Taxes are your biggest expense. Managing your taxes shrewdly can help maintain your lifestyle. If you choose to ignore them, taxes can take a bite out of your wallet and your freedom to live as you want.
We need to be even more vigilant on taxes in 2021 (and beyond). Here’s why:
- There are clear signs that tax rates both federal and state will be going up.
- New types of taxes, particularly state(s), are being considered. For instance, Washington State has passed a new capital gains tax for high earners. New and higher sales, gas, carbon, and income taxes are also on the table in several states.
- Clients who procrastinate and fail to plan could be stuck with a nasty surprise of higher tax bills.
- Clients entering retirement often fail to realize that their taxes might still go up. People think they can enter retirement with a good nest egg and expect lower taxes on lower income. However, they also lose tax deductions (dependents move away, paying off the mortgage eliminates interest deductions). At age 72, they must start taking distributions on traditional IRA(s) at their ordinary income tax rate. All this income might even make your Social Security benefits taxable, leading to higher Medicare premiums.
- Investments for many clients have grown substantially in recent years with the bull market. At some point, they will realize taxable gains, either because of the need to reduce investment risk or else the simple need for money to live on.
- Taxable accounts are unlikely to benefit from tax-loss harvesting in 2021 as they did in 2020. When the markets corrected this time last year, many clients benefited from our actions to realize taxable losses while keeping them invested. For instance, we sold one fund to realize the loss to write off against taxes (or other gains), and then we reinvested the money into different investments with similar characteristics. Once markets recovered, their investments grew. Yet, their taxes were reduced because of realizing the losses. Given strong markets thus far in 2021, taxable accounts may have to deal with higher capital gains taxes on realized gains.
2020 ended up being a strong year in the markets.
However, we cannot forget that the first 3 months were brutal, especially for those on the cusp of retirement with all their eggs in one basket.
While the S&P 500 fell nearly -40% in less than 2 months last winter, some stocks did much worse.
Those of you in the airline or hospitality industry know what I mean. The Covid pandemic and lockdowns sparked major turmoil in these industries. A number of these stocks took a beating.
Now consider if you put most (or all?) of your investments in one of these stocks. Would you still be able to retire?
In some cases, people were forced to retire at the worst possible time because of corporate downsizing.
Our clients who work with us benefit from diversifying into many different investments. They have the prospect of planning for the future with more confidence because one bad investment won’t derail their retirement.
“How Is AWM Seeking to Shield Clients from Taxes?”
We cannot promise you zero taxes. However, there are many things we can do to help reduce taxes as much as possible. Here are some examples:
- We seek to invest in tax-friendly vehicles for capital growth. For instance, we try to avoid mutual funds that pay high capital gains even if their value declined during the year (such as what happened to some funds in 2008). While other investments do not have this issue. Occasionally, we have found mutual funds that can generate minimal capital gains even if they have a strong year.
- We also seek investments with tax-efficient income. One example is ordinary income. In most cases, we avoid ordinary income generated by REITs and annuities because it is taxed as regular income, not capital gains tax. We also steer clear of partnerships in part because income generates K-1’s that can complicate your tax returns. We gravitate toward qualified income taxed at lower long-term capital gains rates.
- Tax-loss harvesting is a strategy we employ to try to smooth taxes. Taxable accounts with realized gains can benefit when we realize losses on investments. These realized losses reduce the gains that clients have to report on their taxes. Typically, market opportunities abound by selling one security at a loss and buying another similar security. Your money remains invested, but you benefit from taking a loss.
- Investments with tax-free income might prove attractive. Municipal bonds might become more attractive in an environment of rising interest rates, income, and capital gains tax rates. While certain partnerships, such as MLP’s, also could entice taxable investors, they also come with price volatility and potential complications in tax filing.
- Consider Roth Conversions and charitable giving. This can help people in retirement to offset taxes and save more money.
- We are constantly educating ourselves on new tax laws so we can better advise you.
Most people have a family doctor who cares for their medical needs.
The best family doctors know when you need preventative care or a referral to a specialist. Maybe you need a surgeon or a radiologist. That said, you still need your family doctor.
Financial Planners (like myself) work like your family doctor. We look at your situation holistically and help plan for the future.
Accountants are specialists. They have a specific job in preparing your taxes for the previous year(s).
But you need more than a tax preparer.
As a Financial Planner, I can help you proactively navigate tax planning strategies, before issues arise.
Your accountant can only react to the decisions you have already made. They are there to keep you compliant with the current tax laws.
Our goal is to plan ahead of time and avoid big surprises.
What Should You Be Doing Now to Ward Off Taxes?
- Plan for the future. (I cannot emphasize this enough.) Tax planning is more important than ever. Expect higher taxes in the future. Realize that tax laws will become more complex, not less. Seek our help to find ways to reduce the pinch of higher taxes.
- Work with a tax professional if you don’t have one already. For those of you who work with a tax professional outside of our office, have them work with us. We can collaborate to understand better when and how much to capture capital gains, explore Roth conversions, and realize extra income without bumping you up to the next tax bracket.
- Be aware of potential tax law changes in your state currently in discussion in state legislatures.
- Talk to us about how we can help with your taxes. Tax planning is much more than simply filling out the annual tax returns. Ask us how we can help you with strategies to save on taxes: tax harvesting, charitable giving, retirement account conversions, and other specialized strategies.
Special message to business owners:
Taxes will become even more complicated for you. Owning a business introduces another layer of complexity. I urge you to talk to someone because higher and more complicated taxes potentially add even more of a burden to your lives or can take a bigger bite out of your income or savings.
Sincerely,
Petr Burunov, CFP®
President / Wealth Strategist