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Turn Leftover 529 Funds into Tax-Free Treats

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As we round the corner to college graduations, many parents take stock of 529 accounts only to discover funds remain even though the kids have completed their higher education.

When diplomas are awarded and university days fade into the distance, these “leftover” funds don’t suddenly disappear. Rather, they represent an opportunity to enjoy some tax-free treats now—or into the future.

Here are a variety of ways to give leftover 529 funds new life.

Pass the Wealth Through Beneficiary Changes

The IRS offers 529 plan owners flexibility to switch beneficiaries, effectively redistributing funds to (most often) a sibling or cousin.

Consider this scenario: One sibling might attend a public, in-state college and have leftover 529 funds. The other sibling might attend a pricier private institution. Those leftover funds from the older sibling can be a real boon as a younger brother or sister completes his or her degree.

Plan owners can also revert the plan back to a beneficiary’s parent. Perhaps one parent has always harbored a desire to explore master gardening or Spanish classes at the local community college. Leftover 529 funds might be the impetus they need to explore a new interest—and the “investment” might become part of their Purpose in Retirement!

While less common, allowable beneficiary changes extend to grandparents, aunts, uncles, and even spouses of beneficiaries.

The Waiting Game

If you’re patient and are willing to play the long game with family education funding, you can also designate the child of the named beneficiary as recipient of the unused funds.  However, this strategy requires a “look before you leap” warning.

Let’s say Sue established a 529 plan for her son Charlie, who completed his education at Oregon State.  After Charlie completed his degree, the 529 had leftover funds of $30,000. Sue chose to leave the balance alone, keeping funds invested, and did not change the beneficiary designation.

Ten years later, Charlie had a daughter, Miriam. The 529 had grown to $40,000. At this point, Grandma Sue elected to change the beneficiary from Charlie to Miriam, effectively turbocharging Miriam’s college savings.

However, because the funds moved to a beneficiary one generation lower, the IRS required Charlie—not Miriam—to file a gift tax return. While this didn’t cost him any money today, it does count toward his lifetime exemption, which stands at $13.6 million in 2024.

“Eating up” some of Charlie’s lifetime exemption isn’t necessarily a bad thing—it’s just good to keep in mind with any beneficiary changes that move one generation lower on the family tree.

Save Funds for Graduate School

According to data from the National Center for Education Statistics (NCES), approximately 21% of individuals with undergraduate degrees pursue further education in graduate school.

Surplus 529 funds that remain after undergraduate studies can be earmarked for graduate school expenses.

Repurpose With a 529-to-Roth Rollover

In January 2024, SECURE 2.0 introduced a new avenue for plan holders with leftover funds: the 529-to-Roth rollover option.

This option allows for penalty-free, income tax-free transfer of funds from a 529 to a Roth IRA in the beneficiary’s name, provided the 529 has been active for at least 15 years and the funds being moved were contributed 5+ years ago.

There are constraints to consider if you choose this route: The annual contribution limit of $7,000 in 2024 still applies, and there’s a lifetime cap of $35,000.

Let’s go back to Sue’s story to illustrate.

When Sue’s son Charlie was 8 years old, Sue decided to invest a portion of her employer stock options in his future college expenses. She established a 529 account with an initial contribution of $20,000, followed by annual contributions of $10,000 for the next decade.

By the time Charlie turned 18 and headed off to Oregon State for an engineering degree, Sue had amassed a balance of $150,000 in Charlie’s 529 account. After covering Charlie’s eligible expenses, Sue found herself with $30,000 left in the plan.

After consulting with her Vista team, Sue opted to transfer $6,000 per year from Charlie’s 529 to his Roth IRA. Over the course of five years, this strategic maneuver successfully shifted $30,000 into Charlie’s Roth IRA, where it could grow tax-free, providing him with a robust foundation for his own retirement savings journey.

It’s Okay to Take a (Non-Qualified) Bite

Even the best laid plans can hit a snag, and that’s perfectly normal!

If the previously mentioned options don’t quite fit the bill, 529 plan holders can make a non-qualified withdrawal in which the withdrawn amount is divided proportionally between contributions and earnings.

The “earnings” portion of the withdrawal is subject to ordinary income tax, in addition to a 10% penalty.

Remember, just like enjoying a dessert, sometimes it’s okay to indulge a little. If that indulgence comes with a bit of extra work—whether on the treadmill or in handling taxes—that’s just part of the balance.

Mind the Gap, Mind Your Money

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Last month, I met with a couple who found themselves in a real pickle.  

After decades of saving into their 401k’s and exercising company stock options, they’d amassed quite the nest egg. They began paying more attention to their portfolio, growing nervous as a result of the occasional large swings in its value. Toward the end of 2022—which turned out to be the worst year since 1937 for a traditional “balanced” stock and bond portfolio—they couldn’t stomach it anymore. They sold their investments in favor of cash.  

At the time I met them, a year had passed since that emotional decision. With global stock markets notably higher, they found themselves emotionally paralyzed. Should they get back in now? Or should they wait for stocks to retreat to lower levels before recommitting to the long-term approach they wished they hadn’t abandoned?   

Chasing Profits, Diminishing Returns

Sadly, this couple isn’t alone. Too many investors fall prey to emotions in thinking they can successfully “time the market.”  

As common as a New Year’s fitness resolution, market timing is a short-term strategy that seeks to get out of stocks in advance of declines and re-enter markets before upswings. Just as likely to fizzle out, however, market timing too often prevents investors from fully capturing the rewards markets have delivered over time.  

According to a new study by Morningstar1, investors’ performance-chasing behavior costs them dearly–reducing earned returns by more than 20% relative to what markets delivered.  

Over the decade ended December 31, 2022, the average mutual fund in Morningstar’s study earned 7.7%, per year. The average dollar invested in those funds, however, earned just 6% per year. That’s an annual performance gap of 1.7%, reflecting the cost of investors’ timing decisions.  

The graphic below illustrates the performance gap for the various investment sub-categories in Morningstar’s study. 

 

 

While the overall performance gap was 1.68% per year—more than 20% of the funds’ total return—the behavior penalty was smaller in some categories and larger in others.  

A few observations:  

  • The timing penalty was smallest in the “allocation” category, perhaps indicating investors with a balanced stock/bond approach may be less prone to reacting to the inevitable ups and downs of investing.  
  • The performance gap was the largest in more niche categories, such as sector funds, the greater historical volatility of which seems to encourage poor behavior. 
  • The average investor in the “alternative” category—which includes managed futures, long-short equity, and options strategies—realized negative returns during a period in which the average U.S. stock fund returned nearly 11%. Ouch!  

Discipline is Key

The idea of market timing is certainly appealing:  Buy an investment at or near the trough, sell at or near the peak, and move on to the next one.  The problem is that only in hindsight are those peaks and troughs clearly visible.  

Morningstar’s study shows that markets move too sporadically and trends are too unpredictable to be consistently exploited by market timers. Those without a long-term plan or emotional discipline fall prey to the impulse to “do something” in their portfolios, when the evidence shows it is better to stay put. 

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1 Mind the Gap 2023: A report on investor returns in the United States. Morningstar. July 31, 2023. 

Cryptocurrency Dreams and Blockchain Schemes: Should You Get in on the Action?

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Cryptocurrency is among the latest, supposedly greatest, fads these days. According to the University of Chicago, 1 in 10 Americans surveyed bought some of the stuff in 2021. When Coinbase (the nation’s largest digital currency exchange) launched its Initial Public Offering (IPO) last April, The New York Times described it as cryptocurrency’s “coming out party.” Even my 10-year-old asked about it recently (in a rare flash of idle curiosity about what Dad does for a living).

Speculative Trades and Investor Escapades

It doesn’t matter whether we’re talking about Bitcoin, Ethereum, or any of the thousands of considerably smaller contenders whose popularity has been waxing and waning of late. Our position at Vista remains the same:

Trading in and out of cryptocurrency isn’t investing; it’s speculating.

Investing focuses on building durable wealth and consistently achieving your financial goals. Simple success is found by positioning yourself to capture the market’s broad, expected returns over time, eliminating any risks you can, and managing the ones that remain.

Speculating is a crapshoot, which lowers your odds for investment success. As financial analyst Vitaliy Katsenelson observed: “My wife’s relatives pay little attention to the US Government’s or Fed’s balance sheets. They are interested in bitcoin for one reason only – it is going up.” Like the extraordinary “winners” you’ve read about in the popular press, you may get lucky by riding a cryptocurrency’s shooting star. But what about all the rest who have lost wealth or at best broken even in the attempt? You’re far less likely to hear about these more mundane outcomes.

The Luck of the Draw

Trading in cryptocurrency resembles another trendy trade these days—vintage sports trading cards. Trading cards??? You read it right: those packs you used to get along with a stick of stale bubble gum. Earlier this year, hot off the success of Netflix’s “The Last Dance” documentary, a mint condition Michael Jordan rookie card sold at auction for $215,000, only to sell weeks later for $738,000.

These numbers are similar to the kinds of wild swings we see regularly among cryptocurrencies’ hottest hands. For example, consider year-to-date weekly numbers for Bitcoin vs. the S&P 500 Index (a proxy for U.S. large-cap stocks). The relatively smooth flow of light-green dots represents S&P 500 weekly returns. The wildly bouncing darker balls belong to Bitcoin.

What About Blockchain Technology?

In a recent post, “The IPO Enigma,” we described how IPOs do not make for good investments at their outset but are still essential to fueling overall markets. Likewise, we are not keen about trading in cryptocurrencies, but they’re not entirely for the birds.

In fact, one of the most exciting global supply chain developments we’ve seen over the last few years grew out of cryptocurrency innovations. We’re talking about the invention of blockchains, the underlying technology powering most cryptocurrency processes.

Without diving too deep, blockchains are a new breed of processes for facilitating strong, yet globally decentralized check-and-balance systems. You might compare their game-changing possibilities to the opportunities your mobile device brought over the rotary phone.

Here are a few examples to illustrate the possibilities:

Maersk + IBM—Shipping at Warp Speed: How much red tape is involved in shipping a case of avocados from Mombasa to Rotterdam? With sovereign interests, stormy seas, a perishable product, and a great deal of money involved, the answer is: a lot. What if we could build a blockchain ledger across the shipper’s, receiver’s, and customs agents’ end-to-end processes? IBM and shipping titan Maersk have been collaborating on achieving just that, hoping to save carriers up to $38 billion annually.

Walmart + Suppliers—Catching Culprits: It’s never a bad idea to be a locavore when possible. But when widespread food crises occur—such as an outbreak of salmonella in our salads—blockchain has been helping corporations like Walmart and its suppliers track sources within seconds rather than weeks. As envisioned by Frank Yiannas, Food Safety VP at Walmart, “[With blockchain technology,] a customer could potentially scan a bag of salad and know with certainty where it came from.”

Vanguard + Symbiont—Instant Index Info: The faster an index provider can share its data with global market participants, the more efficiently we can expect markets to operate. Vanguard has been partnering with Symbiont on blockchain technology accordingly. As reported here, “The partnership has enabled index data to move instantly between index providers and market participants over one decentralized database, resulting in improved benchmark tracking and cost savings for clients.”

Harness the Best, Ignore the Rest

So, yes, we’re fascinated by blockchain’s digital ledger capabilities and its many other promising applications. Integrating it into the global supply chain could improve transparency, efficiency, and cost. This could translate to increased revenue and profits, which in turn should enhance company earnings and shareholder dividends, which are the fundamental variables that drive—you guessed it—the returns you earn as an investor.

See the beauty? But once again, please don’t rush out and stock up on blockchain enterprises in your investment portfolio. No matter how exciting a venture may seem, chasing after it still runs contrary to the intent of investing.

Especially if you’re the nostalgic type, you may still enjoy swapping vintage baseball cards with your friends, for fun if not for profit. For your family’s real-life investing, we suggest skipping any card runs or crypto-crazes, and investing instead for the long run.

By holding Vista’s style of low-cost, globally diversified investment portfolios, you can expect to earn a measure of whatever wonders the next amazing technologies bring, without having to speculate on the bleeding edge of any given game.

RSUs or Stock Options: Which is Better?

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Historically a staple of startups and tech firms, restricted stock units (RSUs) are now finding a home in a wider range of employee incentive plans, alongside stock options.

Nike, for instance, allows employees to choose from RSUs, nonqualified stock options, or a 50/50 mix of the two.

So, what should you do if you’ve been offered these options? Let’s break it down.

What Are RSUs and Stock Options?

RSUs are a type of equity-based compensation, where employees are granted units that convert to shares after a vesting period. These shares can be sold or held indefinitely once vested.

Nonqualified stock options, on the other hand, give employees the right to purchase company shares at a set price after a vesting period. These options expire 10 years after being granted.

How Do They Compare?

Risk & Return

Stock options rely on a rise in a company’s stock price to hold value — RSUs don’t.

With options, if the stock price stays the same or drops below the grant price, your options become worthless. But with RSUs, as long as the stock price is above $0, your shares will always have some value.

The value of stock options can vary: the higher the stock price above the grant price, the greater your potential gain. In contrast, RSUs have a fixed value based on the stock price at the time they vest.

Bill Gates famously highlighted this volatility, saying, “Either [an employee] can buy six summer homes or no summer homes. Either he can send his kids to college 50 times, or no times.”

This uncertainty is why companies like Microsoft now offer the less risky RSUs. Other companies, including Nike, have followed suit, often giving employees five times as many stock options as RSUs to account for this added risk.

Taxes

RSUs are taxed as ordinary income when they vest, and the taxable amount is based on the market value of the shares at that time.

With stock options, a portion is also taxed as ordinary income—the stock price at exercise less the grant price. Unlike RSUs, though, stock options are not taxed until you exercise the option to own the shares. This means you have some flexibility—you can control when taxes are assessed by determining when to exercise the option.

Which Choice Is Best for You?

Let’s consider three hypotheticals:

Jeff

Jeff, 54, is preparing for retirement next year: His stock options will continue to vest as planned, but RSUs won’t. If Jeff retires with unvested RSUs, he’ll forfeit them — meaning he’ll only be able to collect the RSUs that vest in year one and lose the ones from years two, three, and four. 

If he’s okay with the higher risk, stock options might be the better option for him.

Sarah

Sarah, 38, just finished a kitchen remodel and took out a $100,000 home equity line of credit (HELOC) to fund it. While she has savings in a 401(k), her other savings are limited, and she’s relying on her annual bonus to pay off the HELOC. 

For Sarah, RSUs are probably the better choice, as they offer a more predictable income to cover her immediate cash needs. If she went with stock options and they had no value at vesting, she might not have the funds to pay off her loan.

Perry

Perry, 42, is saving more than he’s spending and has nearly $500,000 in his 401(k). He doesn’t have much in savings, but he’s not facing any immediate cash needs. What he doesn’t have, though, are investments outside of his 401(k). Since his retirement savings are tied up and inaccessible without penalties, he wants to start building a diversified portfolio. 

RSUs are likely the best option for Perry. Once they vest, he can sell them and start building a portfolio that gives him more flexibility and access to the broader market.

We’re Here to Help

Choosing between RSUs, stock options, or a mix of both comes down to your personal goals, risk tolerance and tax situation. What works for one person might not be the best choice for someone else.

If you have questions or want to discuss your options in greater detail, reach out to Vista. As always, we’re here to help.

Five Tips for Making the Most of Your HSA

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Unassuming and utilitarian, health savings accounts (HSAs) are a great way to put aside pre-tax dollars for healthcare expenses.

But there’s more to these financial wallflowers than meets the eye.

HSAs offer a cache of tax benefits—some known, some less so—to those willing to give them a second glance.

The Basics

HSAs are not open to everyone.

To qualify, individuals must be enrolled in an eligible high deductible health plan (HDHP).

Account holders can—and should, if possible—contribute the maximum allowed each year. In 2021, this amounts to $3,600 for individuals and $7,200 for families, up a bit from 2020.

Individuals age 55 and older can also throw in an extra $1,000 each year.

The Benefits

Why max out contributions to an HSA?

Triple tax savings, which are like winning the accounting jackpot:

  • Contributions receive a federal (and often state) income tax deduction.
  • Funds—when invested in a mix of low-cost index funds—grow tax-free.
  • Withdrawals for qualified medical expenses are not taxed.

An additional benefit: Unlike flexible savings accounts, HSA balances carry over year to year.

Wisely invested and left to grow, these funds can form a nest egg for unexpected healthcare needs or even healthcare expenses in retirement.

The Bonuses

If this isn’t enough, HSAs really shine when it comes to these five lesser known perks.

 

1. Save on payroll taxes. Contribute to an HSA through a company cafeteria plan and you’ll avoid paying federal and (usually) state taxes, as well as payroll taxes (7.65%). Not even the mighty 401k can claim these savings.

2. Double up a catch-up contribution. If you and your spouse are both 55 or older, you can double your annual $1,000 “catch-up contribution” simply by opening a separate HSA account for your spouse.

3. Take advantage of IRA to HSA funding. While a qualified HSA funding distribution (QHFD) is only allowed once in a lifetime, you can fund an HSA with pre-tax funds (only) from an IRA. Inherited IRA accounts can be used, and this tax-free transfer can count toward the inherited IRA required minimum distribution. Keep in mind you must remain HSA eligible for 12 months after making a QHFD.

4. Maximize funding with the last month rule. If you leave a job mid-year and subsequently enroll in an HSA-eligible HDHP by December 1, you can contribute and deduct a full year’s contribution limit for that year. There’s a catch, though: You must remain covered by the HDHP for the next 12 months to reap the rewards.

5. Maximize family contribution limit for adult children. Do you have an adult child (up to age 26) who is not a dependent but is still covered by your family healthcare plan? If so, you can set up an HSA plan for your child and fund it with the full family plan contribution limit of $7,200. Your son or daughter will receive a tax deduction in that amount, a great way to turbocharge initial funding.

The Bottom Line

Making the most of an HSA is a matter of seeing it for what it really is—an ace up your sleeve.

If you’d like to maximize the tax advantages of your HSA or strategize a long-term plan for your account, contact Vista. We’ll help you see this wallflower for the star it really is.

Answers to Your Top Open Enrollment Questions

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Fall. It’s the time for homecoming, football, Halloween, and…open enrollment.

While specific open enrollment dates can vary from employer to employer, open enrollment allows employees to opt in or opt out of an array of benefits.

Elections are binding for a year, so it’s important to choose wisely to ensure proper coverage and to maximize tax savings.

The following questions and answers can guide your decisions.

High Deductible Health Plans vs. Traditional Plans

Q: Should I choose a high deductible health plan (HDHP) or a traditional plan?

Many employers offer a choice of health insurance options. A high deductible health plan (HDHP) has lower monthly premiums but employees pay more before insurance kicks in.

According to the Kaiser Family Foundation, employees pay an average annual premium of $6,400 for an HDHP and $7,700 for a traditional single coverage PPO plan, a difference of $1,300 per year.

This means if you expect to pay more than $1,300 in deductibles, you’d be better off going with a traditional plan.

Another consideration: HDHPs can be paired with a health savings account (HSA).

Q: Is an HDHP/HSA combination right for me?

It might be. HDHP/HSA combinations are best for healthy families that do not expect to have hefty medical bills.

To participate in an HSA, you must be enrolled in an HDHP.

And the icing on the cake: If the HDHP/HSA combination is right for you, you’ll also enjoy the only triple tax-free investment available.

HSA contributions—which can be used to cover deductibles or out-of-pocket medical expenses—are free from federal and most state taxes, earnings are tax deferred, and qualified withdrawals are tax free.

Health Savings Accounts

Q: How much can I contribute to an HSA?

In 2019, an individual can contribute $3,500 and a family $7,000 to an HSA. Folks over 55 can make an additional $1,000 catch-up contribution.

Q: What are the immediate HSA contribution tax savings?

Immediate tax savings are a function of your federal tax bracket, the state you live in, and whether you’re able to make contributions through a payroll deduction, which saves on social security and Medicare tax withholding.

Dependent Care and Deferred Compensation

Q: Is a dependent care flexible spending account (FSA) for me?

If you have kids in daycare, summer camps, or before/after school programs, this benefit is for you.

You can use pre-tax dollars (free of income tax and other payroll taxes) to pay for these expenses.

You’re capped at $5,000, but if your effective tax rate is 30%, taking advantage of dependent care FSA comes out to an annual tax savings of $1,500 per year.

Q: What about deferred compensation?

Some highly compensated workers have an additional benefit to consider—deferred compensation plans.

At Nike, for example, employees make this election in the fall for either their base pay in the subsequent calendar year, or their performance bonus, or long-term incentive plan.

We’ve written extensively on the pros and cons of deferred compensation plans to help you decide whether participating in one is best for you.

How Vista Can Help

By taking your specific situation into account, Vista can help you evaluate tax implications of your open enrollment choices and get you off to a healthy start in 2020.

Are Your Beneficiary Designations Up to Date?

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Often overlooked but deserving of special attention, beneficiary designations help pass along assets upon the death of an account holder.

To prevent undesired outcomes and optimize wealth transfer to desired recipients, it’s important to keep these beneficiary designations current.

When and What to Update

Stories of assets inadvertently passing to ex-spouses after an individual failed to update beneficiaries abound. That’s because beneficiary designations often override instructions left in a will.
When there’s a change in marital status or in legacy goals, it might be time to update beneficiaries. Account holders should review the following:

  • Retirement plans (401k, IRA, Roth IRA)
  • Taxable accounts with ‘transfer on death’ designations
  • Life insurance policies and annuities
  • Stock options, restricted stock, employee stock purchase plans
  • Deferred compensation plans

It’s a good idea, too, to have a backup plan. Designating a contingent beneficiary directs assets to a “backup” beneficiary if for some reason the primary beneficiary isn’t around.

Complex Beneficiary Designations

Sometimes a beneficiary designation doesn’t fit the boxes provided on forms, such as when a designation is more elaborate than “100% to my spouse—and if he/she predeceases me, 50% to each of my two children.”

Many institutions allow individuals to submit a written document—typically provided by an estate planning attorney—instructing how assets will be distributed in cases of complex designations.

These lengthier beneficiary designations frequently accompany estate plans that include trusts or complex tax planning.

Per Stirpes vs. Per Capita

Latin for “by roots,” per stirpes calls for each branch of a person’s family to receive equal distribution of assets if one of multiple beneficiaries predeceases the account holder.

Consider Pete, a widower with two children, Erik and Stephanie. Erik and his spouse have three children, and Stephanie and her spouse have two children. Pete designated Erik and Stephanie as 50% primary beneficiaries.

Suppose Pete’s children predecease him and Pete subsequently dies without changing beneficiaries. Per stirpes, Stephanie’s two children would each receive half of his 50% and Erik’s three children would each receive one-third of his 50%.

By contrast, Pete could also elect to distribute assets per capita, or “by heads.” This means that if both of Pete’s children predecease him, the surviving five grandchildren would each get one-fifth of the assets.

Charitable Planning

Using retirement plan beneficiary designations to fulfill charitable bequests can be an effective way to optimize wealth transfer.

As a tax-free entity, a nonprofit that receives assets through a retirement plan beneficiary designation receives 100% of the amount.

While an individual beneficiary of an inherited retirement plan has some flexibility in the timing of paying taxes, plan assets are subject to ordinary income taxes as they are withdrawn.

If all or a portion of an estate will be directed to charity, sourcing this bequest from tax-deferred assets will optimize wealth transfer to children or heirs.

Talk to the Experts

For questions on designated beneficiaries, we are here to help. We routinely review beneficiary designations in our regular account reviews. If something has changed since our last conversation, please reach out to us.

In addition, your estate planning attorney can help structure your beneficiary designations to align with your legacy goals.

What the Dow Tells Today’s Investor

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The Dow.

If you have a pulse on the market (or a pulse at all), you’re probably familiar with it.

Scrolling across the bottom of television screens, scrutinized by analysts, and forced upon us by radio deejays, Dow Jones Industrial Average updates are everywhere.

What do these updates mean?

Well, they give us a sense of how stock prices of a few dozen large American companies have changed. Beyond that, it’s hard to tell.

Not the Total Picture

During the postwar boom of the 1950s, the Dow might have been viewed as a strong indicator of how our economy was doing. Today, it’s perhaps a better contributor to investor anxiety than a reliable gauge of portfolio performance.

Keep in mind, the Dow is a collection of just 30 large cap U.S. stocks with a combined market capitalization of approximately $6.8 trillion.

By comparison, the S&P 500 Index includes 505 large cap U.S. stocks with approximately $23.8 trillion in combined market cap. Broader still, the Wilshire 5000 includes about 3,500 U.S. stocks with a combined market cap of over $30 trillion.

The broadest measure of the global stock market is the MSCI All Country World Investable Market Index. Covering over 8,700 large, mid, and small cap stocks in 23 developed and 24 emerging market countries, it has a combined market cap of more than $50 trillion.

While that index is the best reflection of how stocks in a globally diversified investor’s portfolio have performed, you won’t hear it referenced in daily media sound bites.

Putting Point Drops in Perspective

It can be alarming to hear reports of the Dow tumbling, say, 500 points.

But a move of 500 points in either direction is less meaningful now than in the past, largely because the overall index level is higher today than it was years ago.

In 1985, when the Dow was near 1,300, a 500-point drop meant a nearly 39% loss. In 2003, when the Dow was near 10,000, that same drop meant a 5% loss. And in 2018, with the Dow near 25,000, a 500-point drop dwindled to a 2% loss.

A Different Take on the Dow

Despite his pioneering creation, Charles Dow is said to have observed his own index infrequently—once a quarter or once a month, at most.

Today, we know not to draw broad conclusions about the overall health of the market from any narrowly focused stock average.

At Vista, we favor broader measures like the Wilshire 5000 or the MSCI All Country World Index, which reflect the performance of a larger group of companies.

In the meantime, the media will continue to report the Dow’s daily point swings. That’s perfectly fine.

Just remember they’re simply sharing one data point in what amounts to a small drop in the pool for most of our clients.

Guidelines for Using 529 Funds

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This post is Part Two of a three part series on Oregon’s 529 College Savings Plan. In Part One, we looked at recent plan changes. In this installment, we share how to withdraw funds from your plan.

Hard to believe, but it has been 15 years since we first researched 529 college savings plans to come up with best recommendations for our clients.

Back then, these clients had preschoolers. Today, these “preschoolers” are about to head to college.

It’s now time to put those diligently accumulated 529 funds to good use.

Here are some tips for getting started.

What Qualifies for Tax-Free Withdrawals?

First off, keep in mind that expenses and qualifying 529 distributions must occur in the same calendar year.

Qualifying expenses include tuition, fees, books, supplies, computers, and computer-related equipment. Room and board also qualifies as long as your student is enrolled at least half-time.

One caveat: If your student plans to live off campus in housing not owned or operated by the college, you cannot claim expenses in excess of the school’s estimates for room and board.

Do I Need to Keep Records?

Yes. While the 529 plan administrator calculates the earnings portion of any withdrawal, you must keep accurate records and receipts of qualified expenses for the IRS.

If withdrawals are equal to or less than your student’s qualified higher education expenses (QHEEs), then withdrawals—including all earnings—are tax-free.

If withdrawals are greater than QHEEs, then taxes, and a possible penalty, will be due on earnings that exceed qualified expenses.

What’s Better—Direct Transfer or Reimbursement?

To simplify record keeping, you’ll probably want to make payments directly from your 529 plan to your student’s educational institution.

If you go this route, allow ample time for the 529 plan to process the request. The plan will need to sell securities and issue a check, and the school will need time to process the payment.

Alternatively, you can pay expenses directly and then request reimbursement from the 529 plan.

Any Other Tips?

In an appropriately structured age-based 529 plan, investment growth slows substantially and plan investments assume less risk as the beneficiary nears college age.

With college inflation costs potentially outpacing a 529 plan’s growth potential at the tail end of age-based plans, what should you do?

One option is to pay a few years of tuition up front in your student’s freshman year. This can take the bite out of potential inflation and reduce total tuition by thousands of dollars.

Most institutions will gladly accept funds early and will offer refunds in the event a student transfers to a different school. Be sure to check school policies.

Why Did I Receive a Tax Document?

If you paid your student’s first college tuition bill in the previous calendar year, expect to receive IRS Form 1099-Q. This form is produced when you withdraw funds from college savings plan accounts.

Don’t fret—this amount is not subject to tax. Form 1099-Q simply records distribution amounts. Be sure to provide this document to your tax preparer.

Where Can I Find Help?

Just as we advised you 15 years ago on the best 529 plans available, Vista is here to help as you send your student off to college.

Are You Maximizing Your 401k Plan?

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Not one to make New Year’s resolutions?

Fine, but you may be missing out if you don’t resolve to maximize your 401k plan this year.

If you’re already contributing the full amount allowed and leveraging an employer match, you’re off to a great start. But there’s more you can do to supercharge your 401k.

Emulate the Optimal Portfolio

Unlike a brokerage account that can invest in virtually any publicly traded stock or mutual fund, 401k plans are limited to investment funds provided in a plan’s lineup.

Vista recommends a mix of investment choices that closely mirrors the Optimal Portfolio. This emphasizes low-cost index funds and keeps a lid on fees—ultimately maximizing 401k contributions.

Leverage the Employer Match

Not taking full advantage of a plan’s employer match is leaving real money on the table.

Spreading employee contributions evenly throughout the year versus front-loading contributions can have a dramatic effect on the amount an employer contributes to the plan—so it’s important to understand how different plans calculate the employer match.

True Up Contributions

Some plans only provide a match during pay periods in which the employee makes a contribution.

Certain employers will true up contributions, which means participants receive a matching contribution based on annual deferrals into the plan, regardless of timing.

A Deloitte study found that nearly nine in ten companies match per pay period—and just 45% conduct a true-up.

Timing Matters

What does this mean for you? Take two workers, Alison and Jeff. They both earn $100k per year and defer 19% of their annual salary to their 401k.

Alison evenly disperses her contributions throughout the calendar year. Her employer match is $250 per month, or $3,000 a year. This makes her total annual employee and employer 401k contribution $22,000.

Jeff, on the other hand, frontloads his 401k contributions over the first 3 months of the year. This is generally a reasonable strategy—it allows Jeff to productively invest his contributions sooner.

Jeff’s employer match is also $250 per month. Without a true up plan provision, however, he loses out on his employer match. Jeff only gets $750 a year—$250 for each of the three months he makes a contribution.

By not contributing throughout the year, Jeff leaves $2,250 on the table. His total annual employee and employer 401k contribution ends up being only $19,750.

Optimize Pre-Tax vs. Roth Contributions

After leveraging the employer match, an employee may be able to choose between making traditional pre-tax contributions or after-tax Roth contributions.

Depending on an individual’s tax bracket and time horizon, the Roth election could be favorable.

In 2019, an employee can make up to $19,000 in pre-tax or Roth 401k contributions. Employees over 50 can make an additional $6,000 catch-up contribution.

It’s worth noting that while some plans allow the employee to direct their contributions to pre-tax or Roth, employer contributions will always be allocated toward the pre-tax portion of a 401k plan.

Make After-Tax Contributions

Some plans also allow employees to make additional after-tax contributions to their 401k once the $19,000 maximum is met.

Suppose someone socks away $19,000 in employee contributions, $9,500 in employer contributions, and an additional $27,500 in after-tax contributions in their 401k.

While earnings on these funds do not grow tax free (unless the plan allows a backdoor Roth conversion), a few years of maximum after-tax contributions will add up to a sizeable amount that could eventually be moved over to a tax-free Roth IRA.

Look for the Backdoor

To isolate after-tax contributions and immediately convert these funds to Roth 401k investments, some plans include a provision known as a mega backdoor Roth contribution.

This feature, when available, is the ultimate boost to a 401k because it allows after-tax contributions to grow tax free.

Vista Can Help

To maximize your 401k, call us to discuss your goals and plan provisions. We are happy to help.

Is A Deferred Compensation Plan For You?

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As an executive or high earner, you may have the option to participate in a deferred compensation plan through your employer.

Many large organizations—approximately 92% of Fortune 1000 companies—give employees the option to set aside part of their annual salary or bonus, to be paid at some point in the future. Employees can postpone today’s tax liability and potentially benefit from tax-deferred growth.

If you’ve been offered access to a deferred compensation plan, here’s what to consider:

Q: Do you have excess savings?

A: If you’re already maximizing contributions to your 401(k) and have excess savings you won’t rely on in the foreseeable future, a deferred compensation plan could be worth considering.

If, however, you anticipate needing funds before leaving your employer—maybe for a kitchen remodel next month or the purchase of a vacation home next summer—deferring might not be for you.

Q: Should I defer my base salary, bonus, or both?

A: The amount of compensation eligible for deferral and distribution of funds vary by employer. Your cash flow needs and tax situation will help determine what and when to defer.

At Nike, for example, eligible employees can defer up to 100% of three different sources of compensation: next-year’s base salary, performance sharing bonus, and long-term incentive plan compensation.

Because these three sources of compensation are paid out in different years, an election to defer them will impact future years’ taxes differently. A broader understanding of your earnings and taxes over multiple calendar years is needed to best determine the source—and amount—of compensation to defer.

Q: What are my plan’s distribution elections?

A: Deferred compensation plans offer a variety of distribution options, including lump-sum and installment payments. Many plans offer both “in-service” accounts—to access funds while still employed—and “retirement” accounts that distribute funds upon separation from service.

To maximize the benefits of a deferred tax liability, employees should consider electing a “retirement” account with the longest distribution period from separation of service. Nike, for example, allows 60 quarterly installments over 15 years.

Q: What are the tax implications?

A: Electing to participate in a deferred compensation plan may reduce the amount of income subject to tax rates today. Future tax rates, however, are unknown. Deferring could shift the recognition of your income from a year in which applicable rates are relatively low to a year in which rates are higher—or vice versa.

Q: What are my plan’s investment options?

A: Employees can often select from a menu of investments, but high-cost or otherwise poor fund choices may offset much, if not all, of your tax-deferral benefit. If your plan’s investment options don’t include well-diversified, low-cost index funds, it may make sense to receive compensation in the current year and invest those dollars in a portfolio of index funds instead.

Q: Are there other risks to consider?

Certainly. By participating in a deferred compensation plan, employees are essentially accepting an IOU from their employer. While funds in a 401(k) are protected if the company runs into trouble, money deferred in a nonqualified plan is not. If your company files for bankruptcy before your deferred compensation is paid out, you may never see that money.

You may already have a significant concentration to your employer via human capital, company stock, and stock options. While there is no magic number for everyone, consider limiting the total exposure to your employer (stock, options, and deferred compensation) to no more than 25% of net worth.

How Vista Can Help

Tax-deferred growth and delayed income recognition (potentially into years with lower taxes) are compelling reasons to participate in your employer’s deferred compensation plan. But the unpredictability of future tax rates and the risk of an unfunded company liability might outweigh these benefits.

Taking the specifics of your situation into account, we can help explore the right approach for you. We’ll evaluate the perceived stability of your employer and plan’s options, while also considering your income and lifestyle needs, risk tolerance, time frame, expected career path, and other assets. In doing so, we aim to put you on a happy and prosperous retirement path.

Margin Loans for Short-Term Cash Needs

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You may have heard of buying on margin.

Once reviled for fueling the Great Depression, this risky practice allows investors to borrow money against their portfolio to purchase additional investments.

But there’s another way to use margin.

In the same way a bank can lend you money against your home equity, a brokerage firm can lend you money against the value of your portfolio’s stocks, bonds, and mutual funds.

This margin loan can be an effective tool to meet short-term financial needs.

How Do Margin Loans Work?

Margin loans work for any situation where you have a significant expense today, but not the cash to cover it for another six months to a year.

Brokerage firms follow certain guidelines to determine which stocks, bonds, and mutual funds are marginable. Most securities traded on the major U.S. exchanges generally fit the bill, but assets held in retirement accounts are off limits.

Generally speaking, 40% to 50% of the account value can initially be borrowed. An investment account worth $2,000,000 that is invested in a diversified portfolio, for example, could provide $800,000 to $1,000,000 in borrowing capacity.

What Do Margin Loans Cost?

There is no cost to set up a margin account, and the balance can be paid off at any time with no pre-payment penalty.

Much like a home equity line of credit, rates for margin loans are variable and are tied to the Federal Funds rate (currently 2%). A “spread” is added to the Fed Funds rate to arrive at the ultimate margin rate.

One advantage of managing close to $1.5 billion in assets is that we can negotiate very favorable margin rates for clients.

A Case Study

Earlier this summer, Joe and Barb found their dream home. It was listed at $800,000. Given the competitive real estate market, they wanted to make a full cash offer not contingent on the sale of their existing home. Their plan was to sell their home for $600,000 after they’d moved into their new digs.

In anticipation of this purchase, they squirreled away $200,000 in savings but needed to come up with the balance to cover the cost of the new home.

Rather than liquidate $600,000 in portfolio securities, we recommended they borrow against their portfolio using margin.

While borrowing against their portfolio did incur the cost of the margin loan, it had the benefit of avoiding the sizeable capital gains tax—$36,000 in Joe and Barb’s case—liquidating securities would have otherwise realized.

Borrowing on margin also kept their portfolio intact, preserving the expected earning power of that $600,000.

In the end, Joe and Barb were able to make a contingency-free offer and closed on their dream home. Three months later, their old home sold and they deposited the $600,000 in proceeds, paying off the margin balance.

During the three months it took to sell their previous home, they incurred margin costs of $7,500. They found that an acceptable price to pay for avoiding the much larger tax bill realized gains would have produced.

An Option to Consider

Using margin not as a trading tool but as a cash management tool can be a savvy way to fund short-term needs, minimize tax implications, and maximize savings.

By understanding your short-term cash needs and unique circumstances, Vista can thoughtfully help you select the right tool in your tool belt.

If you have questions or would like to discuss your options in greater detail, contact Vista.