Financial Newsletter 5.23

Capitalized

To minimize capital gains taxes in an after-tax brokerage account, you can employ several strategies. Here are five key approaches:

1. Differentiate between short-term and long-term capital gains: Short-term capital gains come from investments held for one year or less, while long-term gains arise from investments held for more than one year. Short-term gains are typically subject to higher tax rates based on your ordinary income tax bracket, while long-term gains qualify for lower tax rates.
2. Focus on long-term investments: Holding investments for more than one year allows you to benefit from the lower tax rates applied to long-term capital gains. By adopting a long-term investment strategy, you can potentially reduce your capital gains tax burden.
3. Utilize tax-loss harvesting: Tax-loss harvesting involves selling investments that have experienced a loss to offset capital gains and potentially reduce your taxable income. This strategy can be useful in managing capital gains taxes. However, be aware of wash sale rules, which prevent claiming a loss if you repurchase a substantially identical investment within 30 days before or after the sale.
4. Consider asset location: Strategically placing investments in tax-efficient accounts can optimize tax outcomes. Investments with higher expected returns and significant taxable distributions may be better suited for tax-advantaged accounts like IRAs or 401(k)s. This allows you to defer or potentially avoid capital gains taxes altogether.
5. Plan for charitable contributions: Donating appreciated securities directly to charitable organizations can minimize capital gains taxes. By doing so, you avoid paying capital gains tax on the appreciation and may qualify for a charitable deduction on your income tax return.

Remember, minimizing capital gains taxes requires careful planning and consideration of your individual financial situation. Consulting with a tax professional or financial advisor can provide personalized guidance based on your specific needs and goals.

It’s Called Amortization

In the past 18 months, mortgage rates have risen significantly. According to Mortgage News Daily, the average 30-year fixed-rate mortgage currently stands at 6.82 percent, compared to 2.39 percent on January 1, 2022. Over the same time period, the 15-year fixed-rate mortgage has moved from 2.60 percent to 6.19 percent. With rates meaningfully higher than at the start of last year, a lot of people are asking about moving to a 15-year mortgage for a new home purchase in order to have a lower interest rate. Here are some of the positives when it comes to the 15-year mortgage compared to the 30-year mortgage:

• If you make your regular payments, you’re scheduled to have your mortgage paid off in 15 years instead of 30.
• The interest rate on a 15-year mortgage is typically lower.

That’s it. When you boil it down, those are the reasons why a 15-year mortgage may be advantageous compared to a 30-year mortgage. Now, let’s look at the benefits of a 30-year mortgage compared to a 15-year mortgage:

• Your monthly payment is likely significantly lower because you are spreading your principal out of 360 payments instead of 180 payments.

Once again, that’s basically it. Yes, we could talk about peripheral issues, but at its core, a 30-year mortgage gives you a lower monthly payment in exchange for higher interest rate in most cases.

However, this is where things start to get interesting. While it is true that the 30-year mortgage does have a higher interest rate attached to it, most mortgages allow you to make extra payments towards the principal to pay them off more rapidly. In effect, you could choose to pay your 30-year mortgage off in 15 years by making additional principal payments every month, while still retaining the flexibility and lower required payments afforded by the 30-year amortization schedule. The cost of this flexibility is that extra interest that you would have to pay each year.

For example, if you had a $200,000 mortgage under current conditions, by paying an extra $475 per month, you could have that mortgage paid off in 15 years while paying $119,448 in total interest according to BankRate.com’s amortization calculator. If you didn’t pay any additional money on a monthly basis, you would be paying $270,346 in interest over the course of the loan. By comparison, a 15-year fixed rate mortgage under the above conditions would have the loan paid off in 15 years as well, but would cost just $107,496 in interest over that time period, saving you just under $12,000 in interest costs versus making the extra payments on the 30-year loan. However, the 15-year mortgage does not have the flexibility to reduce payments if you have a change in income, while you could stop paying extra principal payments on the 30-year mortgage in this example.

Really, the question boils down to whether you feel the need to pay your mortgage off in 15 years, and if you want to maintain the flexibility afforded by a 30-year mortgage and its lower monthly payment. There is no right answer, as every family has different priorities, income levels, and expenses, and by walking through the numbers for your situation, you can come to a solution that fits your needs.

Tax Free Lunch

Determining the appropriate amount of life insurance coverage requires considering various factors, including income replacement, mortgage repayment, and funding for future expenses like college tuition. Our framework suggests having coverage equivalent to 1-2 years of income, in addition to funds to pay off your mortgage and enough to cover college costs for your children. Let’s apply this framework to an example.

For aa household making $80,000 per year, with a $300,000 mortgage, and two children with college cost estimates between $140,000 and $550,000, we can determine the recommended life insurance coverage:

1. Income replacement: Our framework suggests having coverage equivalent to 1-2 years of income. For this example, coverage for 1 year of income would be $80,000. To calculate coverage for 2 years of income, we would multiply the annual income by 2, resulting in coverage of $160,000.
2. Mortgage repayment: To ensure financial security for your family, it’s important to have coverage that can pay off your mortgage. In this case, coverage for the $300,000 mortgage would be necessary.
3. College funding: According to Vanguard’s college cost projector, with a 5% inflation rate for college expenses over an 18-year period, the estimated cost of college ranges from $140,000 to $550,000 depending on the type of school attended. This means you would need additional coverage within this range to cover your children’s education expenses.

Based on our framework and the specific figures provided, the recommended life insurance coverage for this example would be:

• Income replacement: $80,000 – $160,000
• Mortgage repayment: $400,000
• College funding: $140,000 – $550,000 (depending on the chosen college cost within the range)
• Total coverage need: Varies between $620,000 and $1,110,000 

It’s important to note that this framework serves as a guideline, and individual circumstances may require adjustments. Factors such as existing savings, other outstanding debts, and future financial goals should also be taken into consideration. Consulting with a qualified financial advisor or insurance professional can help you assess your specific needs and determine the most accurate coverage amount for your situation. Regularly reviewing and adjusting your coverage as your circumstances change is essential for maintaining appropriate protection.

Schedule Your Review

Tax time is a great time to look at your overall financial plan. Our financial advisors are happy to meet with you to discuss your situation and how we may be able to assist you in crafting a financial plan that is right for your situation. Click here to schedule a time to speak with a member of our team about your planning.

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The opinions and forecasts expressed are those of the author, and may not actually come to pass. This information is subject to change at any time, based on market and other conditions and should not be construed as a recommendation of any specific security or investment plan. Past performance does not guarantee future results.

Armstrong Advisory Group, Inc. does not offer tax or legal advice and no portion of this communication should be interpreted as legal or accounting advice. You are strongly encouraged to seek advice from qualified tax and/or legal experts regarding any tax or legal matters relevant to you.

ARMSTRONG ADVISORY GROUP, INC. – SEC REGISTERED INVESTMENT ADVISER
The information contained herein, including any expression of opinion, has been obtained from or is based upon, sources believed to be reliable, but is not guaranteed as to accuracy or completeness. This is not intended to be an offer to buy, sell or hold or a solicitation of an offer to buy, hold or sell the securities, if any referred to herein.

All investments involve the risk of potential investment losses. An investor cannot invest directly in an index. Diversification seeks to reduce the volatility of a portfolio by investing in a variety of asset classes. Neither asset allocation nor diversification guarantees against market loss or greater or more consistent returns. Bonds are subject to interest rate risk and if sold or redeemed prior to maturity, may be subject to additional gain or loss. Armstrong Advisory does not provide any tax or legal advice; please consult with your tax and legal advisers on such matters.