Taking a distribution from a tax-qualified retirement plan, like a 401(k) before age 59.5, is generally subject to a 10% penalty for early withdrawal. The exceptions to paying this 10% penalty are:

• Hardship distributions

• Rule of 55

Are you familiar with how the Rule of 55 works? If you want to retire early, this blog post is significant for you.

What is the Rule of 55?

The Rule of 55 is an IRS provision that allows employees who leave their job on or after age 55 to take penalty-free distributions from their retirement accounts. It’s a life hack! Typically, individuals would face a 10% early-withdrawal penalty if they access their retirement account before age 59.5. The 10% penalty and account accessibility are two of the reasons why people plan to work until at least age 59.5. 

If you are someone who is thinking about retiring early, the following Rule of 55 requirements are necessary:

1. You leave your job (voluntarily or involuntarily) in or after the year you turn 55 years old.

2. Your plan must allow for withdrawals before age 59.5.

3. Your dollars must be kept in your employer’s retirement plan. If you roll them over to an IRA, you lose the Rule of 55 protection.

4. You will likely want your plan to allow partial distributions when you are terminated.

Access to your retirement account at age 55 is available for all employees with an employer-sponsored retirement account. However, if you are considering retiring after age 55 and using funds from this retirement account, you must check whether your plan allows partial distributions. This feature is an opt-in feature for employers to select. We recommend that you work closely with your recordkeeper to ensure you can take advantage of the Rule of 55 in a way that benefits you.

3 Examples of the Rule of 55

Look at a few examples of employees with partial distributions compared to employees without partial distributions allowed in their plan.

Example 1: Partial Distributions Allowed

Danielle can take any amount from her PDX 401(k) account. For example, in October 2022, she can request $30,000. She doesn’t have to take anything out in 2023. She could take another $65,000 out in January 2024.

EXAMPLE 2: Partial Distributions Disallowed

Martin’s employer-sponsored retirement plan does not permit partial distributions. If he wants to access his retirement account at age 57 without incurring a 10% early-withdrawal penalty, he would have to withdraw the entire $450,000. This would result in reporting $450,000 of taxable income for the year of his distribution. Given the tax bracket optimization strategies that exist during retirement years, this may not be Martin’s best solution for accessing dollars before age 59.5.

A couple of alternative solutions for Martin are:

1. Ideally, Martin would have a cash-flow plan to support his expenses until he reaches age 59.5.

2. Initiate a direct rollover of his $450,000 retirement account into a IRA account. Then take distributions as needed but expect to pay a 10% penalty on these dollars. Before paying a 10% penalty on an early-distribution from a IRA, we would recommend that Martin review other cashflow options he may have.

Example 3: Partial Distributions Disallowed

Rebecca, age 56, has $67,000 saved in her most recent 401(k) account with ABC Company. She also has $700,000 saved in her previous 401(k) account with XYZ Company. Neither of these retirement plans allow for partial distributions.

Rebecca retired at age 56 from ABC Company, so she can take the entire $67,000 balance out in one lump sum distribution. She will not owe a 10% penalty on these dollars due to the Rule of 55.

If she were to access any of her $700,000 saved in her previous 401(k) account with XYZ Company before age 59.5, then she would incur a 10% penalty. Not to mention the $700,000 is sitting in a plan that disallows partial distributions so that would be significant taxable income to report in the same tax year. Similar to the example above, Rebecca may consider initiating a direct rollover of her $700,000 into a IRA account for more flexible distribution choices.

What About Other 401(k) Accounts from Previous Jobs?

To qualify for the Rule of 55, you must be terminated as an employee on or after age 55. Therefore, if you have multiple retirement accounts, the only ones that will qualify for a penalty-free distribution between ages 55 and 59.5 are accounts with your termination date reflecting that age range.

One consideration is to roll over a previous retirement account into your current account before you retire. We recommend speaking with your recordkeeper to confirm that your retirement plan features are designed so rollover sources can be accessible by partial distributions.

For example, if Danielle from above had another 401(k) account, she could have rolled that into her PDX 401(k) account before retiring. All the dollars in the account would be eligible for Rule of 55 distributions.

What if I Decide to go Back to Work but have Taken Distributions Already?

Going back to work after you have taken a Rule of 55 distribution should not result in a 10% penalty. If you go back to work for the same company, then you may lose the ability to access funds as an active employee. However, your distributions will not be impacted if you go back to work at another organization.

How are Rule of 55 Distributions Tracked for Tax Reasons?

Custodians and recordkeepers are responsible for providing a Form 1099-R. This tax form reports any distributions from a retirement account. If you take a distribution under the Rule of 55, you would expect to see code 2 in box 7 of your 1099-R form. Code 2 specifies the following:

2 - Early distribution, exception applies (under age 59.5)

If your 1099-R form includes Code 2 in box 7, you will not owe a 10% penalty. Before you initiate a withdrawal between ages 55-59.5, we recommend confirming your record keeper will issue the 1099 in this format.

What Other Resources do you Have?

Retirement is a transition that only happens once in life. You probably haven’t retired before, and you likely won’t retire again. Retirement transitions involve several financial planning considerations and we wanted to conclude this article with additional resources that may be helpful to you:

Your Pre-Retirement Checklist

The 3 Questions to Ask to Build a Solid Retirement Income Plan

Why an IRA Makes More Sense in Retirement than your 401(k)

While the articles are supplemental information, we believe the best way to prepare for your upcoming retirement is to collaborate with our team at Human Investing. Please use this scheduling link to meet with our team to review your unique financial landscape before you start planning your retirement celebration(s): Schedule here.

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Summertime in full swing often means summer jobs for many young people, especially high school and college-age students. Earned income can provide a terrific opportunity for young people to save, think about their future, and begin practicing financial independence.

High school and college students motivated to save and invest can utilize Roth IRA accounts to get the most out of their dollars. Compound interest in action is a pretty magical thing to behold, and the earlier you can earn compound interest working for you, the better! Compound interest, tax benefits, and learning lifelong financial lessons can make for an incredible summer job experience.

Here is why opening a Roth IRA account is an excellent option for those spending their summer working as a high school or college student. 

Tax-Free Benefits

We are big fans of Roth IRAs here at Human Investing. Because the money used to contribute is after-tax dollars, it grows tax free and is not taxed down the road when you take it out…..We love this!

The younger your child starts a Roth IRA account, the more time their tax-free dollar amount in the account has to grow.

Compound Interest Growth

Youth isn’t wasted on the young. In Beth Kobliner’s book Make Your Kid a Money Genius (Even If You're Not): A Parents' Guide for Kids 3 to 23, she uses the following example:  

“Let's say [your teen] puts $1,000 of his summer earnings into a Roth IRA for each of the four years from age 15 to age 18. If he stops and never puts in another penny, but lets the money grow, by age 65 he'll have about $107,000, if the money earns 7% a year. 

But if your kid waits until age 25 and then puts away $1,000 for each of the four years until age 28 and stops, that account will only be worth a little over $50,000 by age 65.”

By taking advantage of a Roth IRA early on (in this example, ages 15-18), you can double your money compared to starting in your twenties. 

Roth IRA Specifics

In 2022, the maximum annual Roth IRA contribution is $6,000 a person for those under 50 years old who are single and making under $129,000 a year.

For those under 18 years old:

For children under the age of 18, they would need to open a Minor or Custodial Roth IRA account. 

Money put in this account must be earned, not gifted (this includes birthday and graduation gifts), and the adult who opens this account for the minor controls the assets until the minor reaches the age of majority (which is 18). 

Adults can also contribute. If your teen earns $3,000 at their summer job, you could either contribute the full amount they earned and let them spend their money, or you could contribute a percentage of your teen’s earnings (like 50%). 

It’s important to note that parents can contribute the money to a teen’s Roth IRA if their teen earned at least that amount. For example, if your teen made $2000, the most that could be contributed to the Roth IRA is $2000 total.

More info here: https://www.schwab.com/ira/custodial-ira 

For those over 18 years old:

For children 18 years or older, their Roth IRA account is now no different than the Roth IRA their parents might have. This account has the same requirements and restrictions as any other non-minor Roth IRA.

Building habits for the long-term

Here are a few ideas from parents on our team about approaching this opportunity with your child who has a summer job. 

As tempting as it is to spend those paychecks on something more tangible (a car, clothes, trips with friends), our children will need to understand the importance of financial independence, hard work, and investing for the future. Old habits die hard, so the earlier they learn these lessons, the better off they will be in the long run! 

You can incentivize your child’s savings by matching their Roth IRA contribution (up to their contribution limit). You can also lead by example. Share with your child why you save and what your financial “why” is. Share your hopes and dreams for their financial future and how their Roth IRA can be a means to this end. 

If you want to read more about Roth IRAs, check out our other blog post by fellow HI team member Nicole: Is a Roth IRA the Right Account for you?

Feel free to reach out to our Human Investing team if you would like more information about Roth IRA accounts. 

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April, May, and June 2022 have been long, emotional months. The purpose of our charts of the quarter posts is to provide financial updates, and it may be no surprise that this post is focused on interest rates, housing prices, and market volatility.

1: Interest rates increased by HALF A PERCENT in May 2022

On May 4, 2022, the Federal Reserve raised interest rates by ½ a percent. While ½ of a percent may feel insignificant, this was the most significant interest hike in more than two decades.

What does an increased interest rate mean for you? It means that borrowing money from the bank is more expensive. It has also historically been good news for your saving and investment accounts.

Specifically, this chart summarizes investment returns since 1990 after the Federal Reserve raised interest rates by at least ½ a percent. As you can see, on average, stocks returned +20.5%, and bonds returned +13.8% one year after the interest rate hike. Only time will tell what happens, but it wouldn’t surprise us if returns got better in the coming months.

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Source: Morningstar

2: How long does it take to get your money back?

During Q2 2022 – from April 1 – June 30, the S&P 500 returned -16%. Checking your account balance hasn’t been a pleasant experience in Q2 ’22.

Most people want to know the answer to the question, “how long is it going to take to get my money back?” Since this was a recurring question this quarter, Andrew Gladhill wrote a blog post called Payback Periods: How Long to Make Your Money Back. We encourage you to read the full article, but we selected one chart to share from this post.

This chart states that 95% of the time, it takes nine months for investors to, once again, reach another all-time high in their account. Said differently, most of the time, the market rewards investors who stay invested for at least nine months. What does this mean for you?

Remaining invested and, in the case of 401(k) accounts, continuing to invest your dollars is the easiest way to see your account balance recover. This can be an uncomfortable experience, and we recommend reaching out to our team if you feel uneasy or want to brainstorm ways to adjust your account strategies.

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Source: CFA Institute

3: Are we heading into a recession?

Source: Google

Are we heading into a recession? Are you feeling worried, fearful, and frustrated? As this chart illustrates, the Google Trend for the search engine “recession” since the beginning of 2022 has quadrupled.

Everyone is looking for an answer that doesn’t exist. We cannot predict if there will be a recession or how long it will last. We know that recessions are a regular, unavoidable part of economic cycles.

Here are a few questions to ask yourself in preparation for a recession:

Do I have job security?
Does my spouse have job security?
What fixed expenses do I have? (Examples may include mortgage payments, car payments, daycare payments, and recurring health care payments)
Do I have emergency savings to pay for my fixed expenses?
Would a recession change my current investment strategy?
Does anyone really know if there is a recession coming?

We also know that compared to the recent past, US Households currently have more cash and cash equivalents in their bank accounts. This chart, dating back to 2015, shows the rise of cash on hand for US Households. We may be more prepared for a recessionary period than we think we are. As the previous recession preparation questions suggest, it is essential to have liquidity during a recessionary period to help pay for fixed costs, protect against a loss of income, and to avoid selling investments while the markets are volatile.

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Source: A Wealth of Common Sense

If you need help answering any of the questions above, please contact your team of advisors at Human Investing.

4: Mortgage rates doubled in Q2 2022

Mortgage rates, as you may have seen, surged in Q2’22. Average mortgage rates went from 3% to 6%, which is the most significant one-week increase in interest rates since 1987. At about 6%, 30-year mortgage rates are back to where they were in November 2008. 

We wanted to share this chart which illustrates the increase in mortgage payments since 2015. As you can see, monthly mortgage payments have increased over time, but 2022 has experienced a remarkable surge in average monthly mortgage payments.

Let’s see how the rest of summer unfolds. Suppose you are in the market to buy a home. In that case, we highly recommend understanding all the costs associated with purchasing a home, including closing costs, property taxes, monthly payments, and repairs.

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Source: Redfin

For a more in-depth overview, read this Redfin article.

Our team is always here for you should you have any questions or concerns about your financial landscape.

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Inflation can lay waste to portfolios and wages, which is one of many reasons why inflation is concerning for laborers and investors alike. Some speculate that the rise in inflation is from supply chain congestion, resulting from labor shortage due to the Coronavirus pandemic. Others hypothesize that a flood of liquidity into the global economy, which stems from quantitative easing dating back to the financial crisis in 2007-2009, is the cause of rising prices. Regardless of the reason, the concern is that gains in wages and market appreciation are muted, or worse, erased, by an escalation in prices for goods and services.

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Inflation’s History

It has been three decades since we've seen inflation at current levels and even longer since inflation averaged double digits (several different times in the mid-70s to early 80s)[1]. Clients of our firm who remember the 1970s recall long gas lines, borrowing for a home purchase at 15%, and investing in treasury bonds at over 10%.

Consider this: in October of 1981, the 30-year mortgage rate was 18.45%[2]. As I type, that sort of rate seems almost unthinkable, yet it's true. To illustrate how it would impact the average homeowner or investor today, imagine a $500,000 home purchase with a 20% down payment. An individual would be financing $400,000 and be left with a $6,175 payment!

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How Does Inflation Work?

Inflation works in a similar way with food, gas, and other products and services we use regularly. Inflation can be viewed as a tax that leaves consumers with less to spend at the end of each month. With consumers facing higher prices, the dollars they spend must go to the staples such as food, housing, and gas—while potentially having less to spend on discretionary items such as travel and entertainment.

To combat inflation, the Federal Reserve (the Fed) will typically increase short-term borrowing costs on member banks—which in turn, trickles down to the consumer. Managing inflation is a primary objective of the Federal Reserve. The inflation target for the Federal Reserve is 2%. With both headline and core inflation trending well above those targets, aggressive rate increases are warranted. Surely the invasion of the Ukraine by Russia has complicated the Fed’s rate decision. My previous article “War and the Market: What Does History Teach Us?” discusses this topic further. Despite the concern over the war in Ukraine, the question is not if the Fed will raise rates. Instead, it’s a matter of how fast the Fed will hike rates and when they will stop.

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Our Recommendations

First, revisit your budget. See where you are seeing the biggest increases as some individuals are impacted far more than others. For example, my brother is a sports fisherman who is impacted much more by the price of fuel than I am with a five-mile commute to work. At the same time, a family of seven will feel food inflation much more than my parents, who have been empty nesters for almost 30 years. Secondly, once you have revised your budget, a conversation with your advisor can be warranted. For some who are living off a fixed income, the process will require pairing back or needing larger distributions from your portfolio. For others, it may prompt a change in your investment mix. While for many clients, the process may entail staying the course.

Investors whose investment horizon is long-term should continue to invest in a diversified, low-cost, equity-leaning portfolio. However, for investors who are either uneasy with market gyrations or have a more condensed investment timeline, multiple levers can be pulled to potentially position the portfolio to hold up well during inflationary times. Many experts agree that treasury bills and private real estate hold up well during inflation. [3],[4] It is also important to note that during inflation cycles, equities do well; however, volatility can increase, making maintaining a portfolio heavy on stocks problematic for investors whose emotions can get the best of them.

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Guidance for Those who are Worried

If you are prone to worry about your investments, there are several actions to consider. First, consider looking at your investments less often. This does not mean a “head in the sand” approach. Instead, if you are looking at your portfolio a few times per day, consider a few times per week. Or, if it’s weekly, consider checking in on your accounts monthly. Second, look at history for context surrounding the volatility. What you will find is that the market, on average, experiences a 14% intra-year drops since 1980. This may not provide you all the peace you want , but having perspective on what is normal can be helpful in curbing emotions. To further combat mixing emotions with investments, read “How to Avoid the Investing Cycle of Emotions” by our own Will Kellar, CFP®. Finally, if the volatility is cause for sleepless nights, you may be someone that needs to take less risk, meaning a conversation with your advisor is warranted.

Because the course of this inflationary cycle is unknown, it is essential for all investors to track their spending to determine what impact inflation has had on budgets. For some, there is plenty of discretionary capital to absorb the increase prices; however, for others, it may be necessary to tighten the belt and prioritize essential spending, to minimize the impact of elevated costs.

[1] U.S. Inflation Calculator

[2] History of Mortgage Interest Rates

[3] Fama, E. F., & Schwert, G. W. (1977). Asset returns and inflation. Journal of financial economics, 5(2), 115-146.

[4] Crawford, G., Liew, J. K. S., & Marks, A. (2013). Investing Under Inflation Risk. The Journal of Portfolio Management, 39(3), 123-135.

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If you have feedback for us, have questions, or would like to hear more on other topics we’ve not already covered, please email us directly at hi@humaninvesting.com. We cherish the emails and questions and look forward to connecting with you soon.

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Home prices and home equity have increased substantially over the last few years, which may leave you wondering if you should sell your home. Wouldn’t selling your home be even more tempting if buying another home wasn’t so difficult?

If you are thinking about selling a home, then you are probably focused on market timing, payments, moving and lifestyle changes. One thing you may have overlooked are the tax considerations of selling a home.

You may be thinking, “wait, isn’t the sale of my main home tax free?”  

It depends.

Primary homes are considered capital assets, like investments such as stocks and bonds. Capital assets are normally subject to capital gains taxes when they are sold. However, primary homes may qualify for a favorable capital gains treatment called the Section 121 exclusion.

For most homeowners, the Section 121 exclusion is one of the greatest benefits of the current tax code. Are you aware of how this exclusion works and how to ensure you qualify?

Start With your Capital Gains

Before making the decision to sell your home, start by calculating your capital gains. A gain on the sale of a primary residence is calculated as such:

Sale price - (Purchase price + Improvements) = Capital Gain

Breaking Down the Section 121 Capital Gain Exclusion and its Qualifications

The 2-out-of-5 year capital gain exemption is crucial for homeowners to understand.

The IRS allows homeowners to exclude part of your home sale from capital gain taxes if you’ve owned your home and lived in it as your primary residence for two of the past five years. The 24 months do not have to be consecutive months, but rather a total of 24 months within a 5-year period. If you qualify for the 2-out-of-5 year rule, then you have the following gain exclusion when selling your home:

The profit mentioned above does not include outstanding mortgage. If there is an outstanding mortgage on the home, this will not impact the Section 121 capital gain exclusion amount. Please read example #1 below to see how mortgages do not impact the overall capital gain.

Partial Gain Exclusions and Benefit Timing

Even if you haven’t lived in your home two out of five of the years prior to selling the home, there may be a way to qualify for a partial gain exclusion. For example, you could be eligible for a partial gain exclusion if you had to move due to work-related reasons, health-related reasons, or for unforeseen circumstances such as divorce or giving birth to two or more children from the same pregnancy.

Homeowners can benefit from this Section 121 capital gain exclusion once every two years. For example, if you have two homes and lived in both for at least two of the past 5 years, both homes are not eligible for the capital gains exclusion at the same time.

Four Examples of the Section 121 exclusion

EXAMPLE #1: SINGLE-FILING TAXPAYER

Jordan purchased a home in 2016 for $350,000 and sold it in 2022 for $560,000.

Jordan lived in her home for these 6 consecutive years. When she listed her home for sale, Jordan still had an outstanding mortgage of $75,000 on her home. As mentioned above, mortgages are not part of calculating the total Section 121 gain exclusion. Jordan has a total gain of $210,000 ($560,000 sale price - $350,000 purchase price). For a single taxpayer, none of this gain is subject to taxes because it is less than the exclusion amount of $250,000. Time for Jordan to enjoy her celebration of choice.

EXAMPLE #2: COUPLE FILING TAXES JOINTLY

Marta and Paul purchased a home in 1999 for $350,000 and sold it in 2022 for $1,000,000.

Marta and Paul raised their children in this home for the past 23 years, except for in 2006 when they rented their home for a sabbatical year. The total gain on the sale of the home is $650,000. They will only pay capital gains on $150,000, since $500,000 is subject to the Section 121 gain exclusion.

EXAMPLE #3: VACATION HOME TURNED TO A PRIMARY RESIDENCE

Samuel and Taylor bought a vacation home on the coast in 2010 for $300,000. They used the home as a vacation home for the first 10 years, and then converted it to their primary residence in 2020. Samuel and Taylor would like to sell their home at some point in 2022 for $500,000.

The first 10 years of ownership are considered non-qualified use. Non-qualified use is any period after 2008 when the home was not used as a primary residence. Examples of non-qualified use are vacation homes, rental properties, investment properties, or homes used in a trade of business. Homeowners cannot take the full tax-free exclusion under Section 121 if a property was held and used for non-qualified use prior to it being held as a primary residence (qualified use).

In this example, 2/12ths of the total $200,000 of capital gain can be excluded from taxable income ($33,333) as qualified under Section 121 and 10/12ths ($167,666) of the total capital gain must be included in taxable income as non-qualified use under Section 121.

*There are some exceptions to non-qualified use. They are listed under the Business or Rental Use of Home section.

EXAMPLE #4: HOMEOWNERS TURNED TO LANDLORDS

Miguel and Jasmine purchased their primary home in 2012 for $500,000. They moved out of the home and started renting it in 2020. They sold their home for $1,000,000 in 2022.

Since they wanted to utilize the Section 121 gain exclusion, they had to sell the home in 2022. To articulate the importance this sale timing, here is a detailed timeline:

2018 – home used as their primary home

2019 – home used as their primary home

2020 – home used as a rental home

2021 – home used as a rental home

2022 – home used as a rental home for most of the year and sold for $1,000,000 on May 15, 2022

Since they sold this home during 2022, which meets the 2-out-of-5 year exclusion rule, they can utilize the full tax-free exclusion on the $500,000 gain. ** They may owe tax on the depreciation recapture.

However, if they waited to sell their home until 2023, Miguel and Jasmine would pay capital gains tax on the entire $500,000 gain since they wouldn’t have qualified for the 2-out-of-5 year exclusion rule in this case. As this example illustrates, being mindful of your timeline for selling a home is critical.

Tax Planning for your Home(s) IS CRUCIAL IN MAXIMIZING WHAT YOU CAN POCKET

As you may have gathered from this blog post, buying and selling homes may involve complicated tax planning. Given the prolonged seller’s market, our team has worked on several tax planning scenarios and strategies for different clients. If you would like to speak to us about your own unique scenario, please reach out to us at hi@humaninvesting.com or 503-905-3100.

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As I write this in May 2022, most major asset classes are down for the year. Stocks, bonds, foreign or domestic, it’s hard to find an investment producing positive returns right now. Since no investor likes to see the balance in their account drop, we have received an uptick in client inquiries about whether it’s worth staying invested. The short answer is yes; we still recommend staying invested. Markets have historically recovered, and grown to new highs. Panicking and selling your investments when they’ve gone down in price is unhelpful for achieving your long-term investment goals. Staying invested when the markets are roiling is easy to say, hard to do.

If you’re interested in a longer, more data driven response about why you should stay invested, keep reading. A lot of client’s concerns boil down to “How long is it going to take for me to make my money back?”. Let’s call this amount of time it takes to hit a new all-time high for a portfolio the “payback period”.

For the returns, I pulled the Ibbotson SBBI US Large-Cap Stocks for equity, and the Ibbotson SBBI US Intermediate-term (5-year) Government Bonds for fixed income. This data compiles the monthly returns from January 1926 to March 2022. I took a 100% equity portfolio (100/0) and added 10% bonds to compare different allocations (i.e. 60/40 is 60% equity 40% fixed income). I assumed monthly rebalancing.

Source: CFA Institute

As the graph shows, the more conservative your allocation, the shorter the time-frame necessary to make your money back. The most aggressive allocations (100/0 and 90/10) can take about 15 years to make your money back. A more balanced investor (40/60 to 80/20) would expect around 7 years as the worst case to make their money back.

I want to emphasize these numbers reflect the absolute worst scenarios over nearly a century of investing. We could always see a new worst case. Typical experiences are usually not as extreme. Even just looking at the 2nd longest time-frame to make your money back, and the longest payback is just over 6 years.

Source: CFA Institute

In most cases, you will make money in a relatively short amount of time if you remain invested. The final graph shows how long your investment horizon needs to be to have made money 95% of the time. As you can see, a majority of the time markets reward investors who stay invested for at least 9 months. That 5% of times where you haven’t made money in 9 months, we have seen some major draw-downs that took years to recover from. Make sure you have positioned yourself in a way where you are comfortable with all possible outcomes.

Source: CFA Institute

So, what do we do with this information? Some perspective for us all:

Understand the Time-frame you’re Investing For

If you’re not accessing funds for 15+ years, you shouldn’t worry about how long it takes to make the money back.

• If you are investing in a retirement account, keep doing that.

• If you move money monthly into a brokerage account, keep doing that.

If you are planning on accessing the funds in 10 years or less, consider incorporating bonds in your allocation to reduce risk, and shorten the time frame to recover a loss in value for your portfolio.

If you’re currently accessing your funds, have a financial plan to understand how you handle downturns in the markets and still achieve your financial goals

• Strategies for this include having a certain amount of cash on hand to cover market downturns, adjusting your budget as needed, etc.

Stay Invested

When you see your account balance down, know that remaining invested is the best way to recover lost value. Most of the time, you won’t have to wait for years to see your balance recover.

Plan in a way that Helps you Sleep at Night

If you can’t handle the thought of waiting seven years to make your money back, a 70/30 allocation may not be right for you. Have a financial plan in place that accounts for the worst-case scenarios, so you know you’ll be able to ride out any volatility in the markets.

Understand History can Only Tell us so Much

The markets could always find a new worst-case scenario. Use history as a guide for setting expectations, not absolute certainty of what is to come.

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It can be agonizing to watch your portfolio decline during a down market. Our human nature is to react erratically, which can be destructive to your financial plan. While it is important to stay the course, that doesn't mean you need to be idle. There is always an opportunity to do something to better your financial house. Here are a few productive things you can do as an investor during a down market: 

Do: 

Take Advantage of Opportunity

Invest cash: Risk assets like stocks are discounted, and as such, now may be a timely opportunity to invest the cash you have on the sidelines. Yes, markets may go down further, so be prepared for additional short-term losses. When investing additional dollars, don't let a desire to time the market-bottom perfectly get in the way of taking advantage of the opportunity.

Look for opportunities to Tax-loss harvest: Tax-loss harvesting allows you to get a tax break for poor-performing investments in a brokerage account. This strategy allows a taxpayer to offset other taxable gains and potentially claim a deduction against ordinary income. This is an unseen benefit for investors who have a brokerage account and want to use poor-performing investments to lessen their tax burden. (See Tax Tips in a Down Market) 

Keep an Eye on your Financial Goals

Rebalance: Market moves can result in a drift of your account's investments. Rebalancing your investments to your desired investment strategy can restore the appropriate level of risk and return to your account. Making sure you have an appropriate amount in stocks will help you take advantage of the possible market rebound. 

Accelerate Savings: Are you systematically saving into an investment account, such as a 401(k), IRA, or brokerage account? Consider making a larger contribution now to take advantage of the opportunity. This is a similar thought process to investing cash. 

Roth IRA conversions: Stock market downturns make for an opportunity to convert traditional IRA dollars to a Roth. When you convert dollars to a Roth IRA, you are responsible to pay income tax on the conversion amount. You are trading the tax-deferred (pay taxes when you withdraw) growth for tax-free growth. Before you complete a Roth conversion make sure you understand the tax implications and talk to your advisor or tax professional. 

An example: Your IRA was valued at $10,000 and is now valued at $8,000 due to market loss. To convert your IRA to a Roth, you would pay income tax on $8,000 rather than the previous amount of $10,000. Any growth from the time of the conversion is now tax-free for qualified withdrawals.  

Stay Educated

Read a book - My favorite personal finance book is the Psychology of Money by Morgan Housel. Housel provides timeless lessons about personal finance, human behavior, and long-term investing. Give it a read and let us know what you think. 

Don’t:

Don't invest short-term cash: Strategic cash cushions do have a significant place in a financial plan. Now is a prudent time to assess your cash holdings. Never use short-term dollars to invest. 

Don't watch your account or market too closely. Staring at a screen during periods of market fluctuations can be poisonous to your emotional wellbeing. Log out, take a deep breath, and go for a walk.

Don’t panic sell - The key thing for many investors is not to panic, stick to your plan. Remember that market declines are normal. This is the price of admission for long-term returns. 

 What We’re Doing for our Clients

Our team at Human Investing continues to carry our methodical approach to help steward our clients’ dollars. Our investment analyst team is constantly looking for opportunities to tax-loss harvest and rebalance. All the while, our Investment Committee persists in our due diligence for opportunities to enhance our investment strategies. 

While it is important to stay the course, that does not mean you need to sit on your hands and do nothing. We hope to provide you with a list of constructive things you can do to better your financial plan. Please let our team of credentialed advisors know if there is anything we can do to help you navigate the current market.  

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A dividend is when a publicly listed company pays out a portion of earnings to shareholders. These can be paid out in cash or given as additional stock. These are given out to reward investors for entrusting their money with the company.

Who Determines the Dividend?

The Board of Directors decides two things:

1. If they are going to issue a dividend or invest the profits back into the company

2. The amount of the dividend

So, how does the Board make these decisions?

Whether or not a company issues dividends to shareholders often depends on how long the company has been around. Companies like Coca-Cola who have been around for a long time have lower growth potential and tend to pay a higher dividend because they see it as the best return for shareholders. If the Board of Directors thinks investing their earnings back into the development of the business will provide a greater return long term, they are most likely going to forego paying out a dividend or increase an existing one.

Many companies, especially newer companies, do not issue dividends. They retain earnings to help with future business activities. See the example below.

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Important Dates to Note

These four dates are important to know if you qualify for a dividend and when you will receive it for owning shares of a company.

1. Announcement date or declaration date: This is when the Board of Directors announces its intention to pay out a dividend.

2. Ex-Dividend date: The ex-dividend date is the trading date on which the dividend will not be owed to a new buyer of the stock, this is one business day before the record date.

   For example: If the stock has an ex-dividend date of June 26th you will only receive the dividend if you purchased the stock before the 26th of June. If you bought the stock on the ex-dividend date or after you will not receive the dividend this time around.

3. Record Date: This is the day on which the company checks its records to identify shareholders of the company.

   Note: If you own shares of the company on its record date and sell your shares after the date you will still receive the dividend for that period. If you want the dividend you need to make sure you purchase the stock at least two business days before the record date.

4. Payment Date: This is the date the company issues the dividend and shareholders are paid out. Companies can pay dividends on a monthly, quarterly, or annual basis.

How Does the Dividend Affect Share Price?

When a company declares a dividend, the price tends to incorporate that dividend into the stock price. The day of the ex-dividend date is the day when the stock price is affected most by the dividend. Since new buyers of the stock will not receive the dividend the price of the stock typically drops by the dividend amount. This is because the dividend is locked into being received by the shareholders as of the previous market close, instead of the new buyers.

How to Receive your Dividend

To receive a dividend for owning shares of a company you must own the shares before the ex-dividend date. If you plan on buying the stock before the ex-dividend date, ensure you place the buy two business days before the record date so that trades have fully settled.

How are Dividends Taxed?

In the tax world there are two types of dividends: qualified and non-qualified.

Most dividends received will be qualified dividends where they will taxed at capital gain rates and receive preferential tax treatment. However, there are a few instances where dividends can be non-qualified and taxed as ordinary income. Such as the examples below.

• Dividends paid out by REITs (Real Estate Investment Trusts)

• Dividends paid on employee stock options

• Dividends paid by tax exempt organization.

• Dividends paid out by credit union, loan associations, insurance companies, mutual savings banks

Dividends are a Great Perk for Owning Stocks

Investing in companies that pay a strong dividend can be a good way to receive a return on your investment as they pay out cash on a monthly, quarterly, or annual basis. Keep an eye out for companies where the dividend isn’t sustainable based on profits. Lastly, make sure to know how your dividends are going to be taxed so you don’t have any surprises when tax time comes around.

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Cash has its place in any financial plan. However, holding too much cash or cash-like investments like a CD or a Money Market account can be one of the most overlooked risks when it comes to long-term planning. 

Inflation Creates Permanent Loss  

Traditional wisdom says if you want to preserve your dollars, keep them as cash. Yes, this level of caution can help reduce short-term volatility or loss of capital. Unfortunately, unbeknownst to many investors, cash is not as risk-free as it seems. Holding too much cash long-term can come at a high price. 

 Inflation is defined by the Federal Reserve as "the increase in the prices of goods and services over time.”[1] For investors, inflation is a silent killer that, if unchecked, can permanently deteriorate their purchasing power. To stress this, see how quickly your money can be cut in half based on different inflation rates.   

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Table 1

Source: Ycharts

Build a Diversified Plan  

Inflation requires investors to think long-term. Balancing temporary risks with combating inflation is an essential element of building a successful financial plan. 

Long-term investors who want to combat rising costs due to inflation should look to build a diversified investment strategy with an appropriate amount of stocks. While the stock market entails short-term volatility, it has never experienced a total and permanent loss. In fact, stocks have done just the opposite.  

Table 2

This graph is for illustrative purposes only. Past performance is no guarantee of future results. Data sources: Health care costs, CMS.gov; Portfolio returns, CFA Institute (SBBI®)

When Should I Hold Cash?

This is not to say someone ought to avoid holding cash altogether. Strategic cash cushions do have a significant place in a financial plan when considering both short-term and long-term financial decisions (see the barbell approach). There is no one size fits all plan. The amount someone should keep on hand should correspond with their living expenses, instability of income, stage of life, risk tolerance, etc. This amount is typically 3 to 12 months of living expenses. However, the permanent risk associated with holding too much should be evaluated, and if possible, mitigated. This starts with a deliberate and personalized plan concerning how much to hold and where to keep it. 

Decisions around cash are just as psychological as they are financial. For this reason, it can be helpful to enlist the help of a trusted partner like Human Investing who has your best interest in mind.   

Sources

[1] Federal Reserve (2016). What is inflation and how does the Federal Reserve evaluate changes in the rate of inflation?

[2] Inflation Data source from 1/1/1926-12/31/2021: Ycharts.

[3] U.S. Centers for Medicare & Medicaid Services. “Projected | CMS.”

[4] CFA Institute (2021). Stocks, Bonds, Bills, and Inflation (SSBI®) Data.

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Did you Make Over $125,000 Individually or over $200,000 as a Married Couple?

There are two new local personal income taxes that became effective for the 2021 tax year. These two taxes, explained below, are specifically for single filers with Oregon taxable income above $125,000 and married jointly filers with Oregon taxable income above $200,000.

These two programs are local taxes, not state taxes. This means that the tax payments go directly to The City of Portland and require an additional filing. We expect high-income earners in the Portland-metro area to have at least three tax returns for 2021: US Individual Income Tax Return, Oregon Income Tax Return and City of Portland.

Like your federal and Oregon state tax return, these local tax returns are also due by Monday, April 18.

Local tax #1: Preschool for All (PFA) Personal Income Tax

In November 2020 Multnomah County voters passed The Preschool For All Program which will provide tuition-free preschool for children that meet the program criteria.

• This local tax is funded by a 1.5% marginal personal income tax on taxable income above $125,000 for single filers and $200,000 for those married filing jointly.

• This local tax is also funded by an additional 1.5% tax is imposed on taxable income over $250,000 for single filers and $400,000 for those married filing jointly

Local tax #2: Portland Metro Tax

In May 2020, Portland-area voters approved Measure 26-210 which will provide homelessness services like shelter, advocacy, and mental health resources.

• This local tax is funded by a 1% marginal personal income tax on taxable income above $125,000 for individuals and $200,000 for those married filing jointly.

• This local tax is also funded by a 1% business income tax on net income for businesses with gross receipts above $5 million.

• The Portland Metro area includes residents of Multnomah County, Clackamas County, and Washington County. For a full reference guide of the Metro jurisdiction use this online tool.

How can I Find my 2021 Taxable Income?

Taxes are complicated. Remember that your income (like your salary) is not the same as your taxable income. For example, you could earn a salary of $140,000 a year but have less than $140,000 of taxable income because of pre-tax retirement account contributions and taking the standard deduction or itemized deductions.

The easiest way to confirm your 2021 Oregon taxable income is to complete an Oregon Income Tax Return. Your taxable income is included on line 19 of your Form Oregon 1040.

If you are a single filer and your Oregon taxable income (on Line 19 on your 2021 Form OR-40) is greater than $125,000 or if you are a married jointly filer and your Oregon taxable income is greater than $200,000 then you likely need to pay your taxes by April 18, 2021.

FINDING YOUR TAXABLE INCOME IN TURBOTAX

1. Login and find the Documents tab.

2. Download your tax PDF. Scroll to the bottom of the PDF for the Oregon return.  

3. Find your 2021 Form OR-40. Line 19 includes your total taxable income.

examples of Calculating your local taxes owed

Preschool For All Tax: $0 because her income is below the $125,000 threshold for individual taxpayers.

Portland Metro Tax: $0 because her income is below the $125,000 threshold for individual taxpayers.

Preschool For All Tax: $6,000.
Tier 1: $400,000 - $200,000 = $200,000 of taxable income. $200,000 x 1.5% = $3,000
Tier 2: Then, $500,000 - $400,000 = $100,000 of additional taxable income. $100,000 x 3% = $3,000

Portland Metro Tax: $3,000.
$500,000 - $200,000 = $300,000 of taxable income. $300,000 x 1% = $3,000

Preschool for All Tax: $0 because they are not a Multnomah County resident.

Portland Metro Tax: $350.
$160,000 - $125,000 = $35,000 of taxable income above the threshold. $35,000 x 1% = $350

How Can I Pay for this Tax?

If you hire a CPA to prepare your individual tax returns, we recommend confirming that they will also file your City of Portland taxes for you. 

If you use an online tax software like turbotax, you will have to visit the Pro.Portland.gov website to submit your tax payments in a separate return. If you are a Multnomah County resident, this process will feel similar to paying your $35 Arts Tax.

What if my Taxable Income is Below the Limits for the PFA and Metro Tax?

You do not need to file anything to the city of Portland if your taxable income is below the limits for both local taxes in 2021. However, if you are a Multnomah County resident then don’t forget to pay your Multnomah County Art Tax for 2021. You can pay for it here: Portland Arts Tax Online Payment.

If you have more questions about the new local taxes, or would like to speak to a financial professional please reach out to us at hi@humaninvesting.com or 503-905-3100.

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With Russia’s invasion of Ukraine this week, many are wondering how a conflict in Europe will influence their own finances. In addressing this headline for our firm, please understand that the loss of life and the disruption of peace weighs heavy on me and our team. While considering investor concerns, our goal is to provide a point of view which I feel we are uniquely positioned to share amid war as a financial management firm.

Markets trade on future expectations. For example, if the market expects new jobs or a strong economy, then people and businesses adjust their decisions today, based on what they believe is coming. Remember how the market crashed when COVID-19 first hit the United States, but bounced back a month later? That’s because people were making choices based on expectations, not necessarily reality.[1] Because war follows a circuitous route, forecasts are less clear. Researchers accurately note that “the impact of conflict on human lives, economic development, and the environment is devastating.”[2]

Previous Wars and Invasions Show That Market Reactions can Range Wildly.

For example, in 1990, Iraq invaded Kuwait and immediately the global stock markets declined.[3] In the three days that followed the Iraqi attack on Kuwait, the Dow Jones Index slid over 6%; yet in the first four weeks of Operation Desert Storm, the Dow gained 17%.[4] Additionally, the European Stock market responded positively to the second conflict with Iraq in early 2000. Stock market history has shown divergent reactions to war.

Surely, the economy of Ukraine will be devastated, but no one knows what the financial repercussions from this Eastern Europe conflict are. For example, when the news broke about Russia’s invasion, the European markets went down around 4%, but the US market went up by about 1.5% at the end of the day. We simply can’t predict the future, and the market changes moment-to-moment, day-to-day. The only real certainty is that volatility will resume as individuals and institutions place their bets on future predictions, and because of this, our client financial plans and asset mixes navigate all types of situations.

Finding your Footing in Uncertainty

Market related volatility is an un-welcomed but natural part of the investing journey, so our client portfolios at Human Investing are constructed with a plan and risk tolerance in mind. For example, a client that has cash needs to support their day-to-day expenses (such as a retiree) will often have a portfolio with equities that pay dividends, bonds that pay interest, and ample cash to cover upcoming obligations. On the other hand, investors who rely on equities should understand that stock volatility is the price we pay for the expected premium we receive in the long run over cash and bonds.

Although the headlines of “war” and “invasion” cause anxiety, the questions investors should ask are, “How is my plan working out?” and “Despite the market volatility, am I still on track?” Keep in mind that although the average annualized return of the S&P 500 since 1926 is approximately 10.5%, market swings may increase considerably. [5]  Investors should think about their financial plan, investment goals, timelines, and overall diversification to determine how well they are prepared to manage the ups and downs. Adjustments can always be made to ease the concern in the short term, but for most of our clients, their financial plan and current asset allocation take into account market downturns, caused by a myriad of events, including invasions and war.  Through it all, we at Human Investing are present in all of life’s ups and downs as we faithfully serve the financial pursuits of all people.

[1] Frazier, L. (2021, February 11). The coronavirus crash of 2020, and the investing lesson it taught us, Forbes. The Coronavirus Crash Of 2020, And The Investing Lesson It Taught Us

[2] Cranna, M. (1994). The true cost of conflict. New York: New Press. The true cost of conflict / | Colorado Christian University

[3] Richter, P. (1990, August 3). Markets react to Kuwait crisis: Stocks: Invasion rocks market; dow slides 34.66, Los Angeles Times. MARKETS REACT TO KUWAIT CRISIS : Stocks : Invasion Rocks Market; Dow Slides

[4] Schneider, G., & Troeger, V. E. (2006). War and the world economy: Stock market reactions to international conflicts. Journal of conflict resolution, 50(5), 623-645. War and the World Economy: Stock Market Reactions to International Conflicts

[5] Maverick, J. B. (2022, January 13). What is the average annual return for the S&P 500? Investopedia. S&P 500 Average Return: Overview, History, and Factors

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Your bonus is not taxed more than regular income.

Have you ever noticed the discrepancy between the bonus payment that was communicated to you and the actual bonus payout? As an example, let’s say your employer announced that you will get a $5,000 bonus, but the upcoming paycheck is only $3,500. What happened?! The common and incorrect narrative is something along the lines of “Bonuses are taxed more than regular income!”

This is not true. Bonuses are taxed at the same rate as your regular income. Please keep reading if you would like to see an example.

Why do we think that bonuses are taxed more than regular income?

Probably because bonus payments are treated by the IRS as ‘supplemental income’, whereas your regular income is treated as ‘ordinary income’ by the IRS.

Supplement and ordinary income are taxed at the same rate. However, supplemental income (like bonuses, overtime pay, severance, and tips) require employers to withhold more taxes. Due to the tax withholding, it feels like bonuses are taxed more than regular pay. And yes, they do have more taxes withheld up front so it does impact your cash-flow.

Because we love round numbers, let’s look at an example of for someone that normally receives a $2,000 paycheck and a one-time $10,000 bonus.

$10,000 bonus example

January 5, 2022: Your employer informs you that you will receive a $10,000 bonus.

January 10, 2022: You receive your paycheck that includes your typical income and the bonus payment.

Your regular income of $2,000 was subject to the following tax withholdings:

15% - federal withholding selected on your W4 Form

8% - state of Oregon withholding tax

23% - total withholding (federal + Oregon)

Your take-home pay is $1,540.

Your bonus paycheck was subject to the following tax withholdings:

22% - federal requirement for ‘supplemental income’

8% - state of Oregon withholding tax

30% - total withholding (federal + Oregon)

Your take-home bonus payment is $7,000. As you can see in this example, the total tax withholding for the bonus payment is greater than the tax withholdings for typical paychecks.

Your tax withholdings are not the same thing as your tax payments.

As shown in the example above, $3,000 was withheld from the bonus payment. This is an upfront payment to the IRS, but it doesn’t mean that this person will actually pay $3,000 in taxes for this bonus At the time of filing their tax return, they may receive some of that money back (a tax refund) or they could end up owing more taxes if they have significant income during the year.

As illustrated above, supplemental income has a 22% tax withholding rate. However, most taxpayers have a lower effective tax rate than that which means they will receive money back from the IRS once they have filed their taxes. We have included an example below to help clarify this concept.

The taxes paid on bonuses are the same as taxes paid on ordinary income.

While tax withholdings are different for regular income and bonus payments, the actual tax rate you pay is the same. Once you file your tax return the actual taxes paid are trued up.

Here is an example of a single tax-payer making a salary of $48,000 a year and a $10,000 bonus. They would see $58,000 appear in box 1 of their W2 Form issued by their employer. The total combined income of $58,000 is then subject to income tax brackets.

The key point is their entire income of $58,000 is subject to the same income tax brackets and end up with the same tax treatment. The difference is only the amount withheld when the bonus is paid out. We know that the $10,000 bonus had 22% in federal tax withholdings, but we can also infer that this person’s effective tax rate is probably lower based on the progressive tax brackets shown in this image.

To be clear, the first $10,275 gets taxed at 10%. The next $31,500 (range is dollars above $10,276 and below $41,775) get taxed at 12%. The remaining $16,225 is taxed at 22%. I encourage you to read the blog post titled 2022 Tax Updates and A Refresh On How Tax Brackets Work if you want a detailed explanation of our progressive tax brackets.

Whether or not this person will receive a tax refund or owes more taxes at the time of filing their tax return depends on the rest of their financial landscape. We can save that information for another blog post!

“Whatever it is, the way you tell your story online can make all the difference.”

— Quote Source

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