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Financial Focus

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Have financial questions? Every week, TheBayNet will spotlight a Financial Focus article on an important topic provided by Edward Jones Financial Advisor Wilman Wai Man Cheung.

Today she'll look at the financial lessons of 2020.

What Can Investors Learn from 2020?

Now that we’re a few weeks removed from 2020, it’s a good time to reflect on such a momentous year. We can think about developments in the social and political spheres, but we also learned – or perhaps re-learned – some valuable lessons about investing.

Here are four of them:

• A long-term perspective is essential. Volatility in the financial markets is nothing new, but, even so, 2020 was one for the books. Of course, the COVID-19 outbreak was the driving force behind most of the wild price swings. Soon after the pandemic’s effects were first felt, the S&P 500, a common index of U.S. large-cap stocks, fell 34% but gained 67% by the end of the year. Consequently, investors who stuck with their investment portfolios and kept their eyes on their long-term goals, rather than on shocking headlines, ended up doing well. And while 2020 was obviously an unusual year, the long-term approach will always be valuable to investors.

• Investment opportunities are always available. The pandemic drove down the prices of many stocks – but it didn’t necessarily harm the long-term fundamentals of these companies. In other words, they may still have had strong management, still produced desirable products and services, and still had good prospects for growth. In short, they may still have been good investment opportunities – and when their prices were depressed, they may also have been “bargains” for smart investors. And this is the case with virtually any market downturn – some high-quality stocks will be available at favorable prices.

• Diversification pays off. Bond prices often move in a different direction from stocks. So, during a period of volatility when stock prices are falling, such as we saw in the weeks after the pandemic hit in March, the presence of bonds in your portfolio can lessen the impact of the downturn and stabilize your overall returns. And this, in essence, is the value of maintaining a balanced and diversified portfolio. (Keep in mind, though, that diversification can’t guarantee profits or prevent all losses.)

• The market looks ahead. The pandemic-driven market plunge may have been stunning, but it made a kind of intrinsic sense – after all, the sudden arrival of a pandemic that threatened lives, closed businesses and cost millions of jobs doesn’t sound like a positive event for the financial markets. But the strong rally that followed the initial drop and continued into 2021 has surprised many people. After all, the pandemic’s effects were felt throughout the rest of 2020, and are still being felt now, so why did stock prices rise? The answer is pretty straightforward: The financial markets always look ahead, not behind. And for a variety of reasons – including widespread vaccinations, anticipated economic stimulus measures from Congress and the Biden administration, and the Federal Reserve’s continued steps to keep interest rates low – the markets are anticipating much stronger economic growth, possibly starting in the second half of 2021.  

All of us are probably glad to have 2020 behind us. Yet, the year taught us some investment lessons that we can put to work in 2021 – and beyond.

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Estate Planning For Blended Families

If you’re in a blended family, you’re already aware of the emotional and financial issues involved in your daily life. But what about the future? When it’s time to do your estate planning – and it’s never too soon for that – you’ll need to be aware of the entanglements and complexities that can get in the way of your vision for leaving the legacy you desire.

You can take comfort in knowing that you’re far from alone. More than half of married or cohabiting couples with at least one living parent, or parent-in-law, and at least one adult child, have a “step-kin” relationship, according to a study from researchers at the University of Massachusetts and other schools. That’s a lot of estate-planning issues.

Nonetheless, the task does not have to be overwhelming – as long as you put sufficient time and thought into it. Here are some ideas that may help:

Seek fairness – but be flexible. Even in a nonblended family, it’s not always easy to be as equitable as you’d like in your estate plans – too often, someone feels they have been treated unfairly. In a blended family, these problems can be exacerbated: Will biological children feel cheated? Will stepchildren? Keep this in mind: Fair is not always equal – and equal is not always fair. When deciding how to divide your assets, you’ll need to make some judgment calls after carefully evaluating the needs of all your family members. There’s no guarantee that everyone will be satisfied, but you’ll have done your best. 

• Communicate your wishes clearly. When it comes to estate planning, the best surprise is no surprise – and that’s especially true in a blended family. Even if you’re the one creating your estate plans, try to involve other family members – and make your wishes and goals clear. You don’t have to be specific down to the last dollar, but you should provide a pretty good overall outline.

• Consider establishing a revocable living trust. Everyone’s situation is different, but many blended families find that, when making estate plans, a simple will is not enough. Consequently, you may want to establish a revocable living trust, which gives you much more control than a will when it comes to carrying out your wishes. Plus, because you have transferred your assets to the trust, you are no longer technically the owner of these assets, so there’s no reason for a court to get involved, which means your estate can likely avoid the time-consuming, expensive and very public process of probate.

• Choose the right trustee. If you do set up a living trust, you’ll also need to name a trustee – someone who manages the assets in the trust. Married couples often serve as co-trustees, but this can result in tensions and disagreements. As an alternative, you can hire a professional trustee – someone with the time, experience and neutrality to make appropriate decisions and who can bring new ideas to the process.
Above all else, make sure you have the right estate-planning team in place. You’ll certainly need to work with an attorney, and you may also want to bring in your tax advisor and financial professional. Estate planning can be complex – especially with a blended family – and you’ll want to make the right moves, right from the start.

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Consider These Types of Tax-Smart Contributions

April 15 is not that far off, but you still have time to make some moves that could favorably affect your tax returns. Specifically, you may want to consider some tax-smart contributions.

You have until the April 15 filing deadline to contribute to an IRA, or to open one for the 2020 tax year. When you invest in a traditional IRA, your earnings can grow on a tax-deferred basis and your contributions may be tax deductible, depending on your income level. And starting with 2020, you can fund a traditional IRA past age 70½. If you invest in a Roth IRA, your contributions aren’t deductible, but your earnings can grow tax free if you don’t take withdrawals until you’re at least 59½ and you’ve had your account for five years. For the 2020 tax year, you can put up to $6,000 in an IRA, or $7,000 if you’re 50 or older. (If you’re a high earner, your Roth IRA contributions may be reduced or eliminated.)

Another type of tax-smart contribution is a “recontribution” – which requires some explanation. As part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act, if you were affected by the COVID-19 pandemic and you were under 59 ½, you could take withdrawals – technically called “distributions“ – of up to $100,000 from your retirement accounts, such as your IRA and 401(k), without paying a 10%penalty. Plus, you could include these withdrawals as taxable income over three years. However, you could also recontribute all or part of the withdrawals back into your retirement accounts for up to three years after taking the money. Because it’s generally a good idea to avoid dipping into retirement accounts before you’re retired, this ability to recontribute can be valuable.

And here’s the potential tax benefit: Any money you recontribute before the tax filing deadline of April 15 (or later, if you get an extension) can be excluded from your 2020 tax return, possibly reducing your taxes. Therefore, your recontribution can offer two potential advantages: more money in your retirement accounts and a tax break this year.

Your tax advisor can help you determine if the withdrawals you took from your retirement plans in 2020 were pandemic-related and qualify for the special treatment described above. Generally, you simply need to demonstrate that you were physically or financially affected by COVID-19. 

Here’s one more tax-related contribution that may be relevant to you: a charitable gift. A few years ago, new legislation greatly expanded the standard deduction, which led far fewer people to itemize. Consequently, their charitable contributions didn’t provide the same tax benefit they had previously. The CARES Act authorized an “above-the-line” deduction for cash contributions to qualified charities for those who don't itemize. For 2020, the maximum deduction was $300; this provision has been extended for 2021, with a new provision allowing a $600 deduction for joint filers. If you do itemize deductions, you’ll want to note that the CARES Act also suspended the 60% of adjusted gross income limit for cash gifts in 2020, a change that has been carried over to 2021.

To learn more about how your contributions, in various forms, can affect your taxes, consult with your tax advisor. The more you know, the better your decisions.

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Put Tax-Smart Investing Moves to Work

We’re now well into what’s known as “Tax Season.” If your income in 2020 was affected by the COVID-19 pandemic, your tax return will reflect it. However, if your earnings were fairly normal last year, you might look at your tax situation and wonder how you could improve it in 2022. One area to look at may be your investment-related taxes.

To help control these taxes, consider these moves:

• Take full advantage of tax-deferred investments. As an investor, one of the best moves you can make is to consider contributing as much as you can afford to your tax-deferred accounts – your traditional IRA and 401(k) or similar employer-sponsored plan – every year. If you don’t touch these accounts while you’re still contributing to them, you can defer taxes for decades, and when you do start taking money out, presumably during retirement, you may be in a lower tax bracket. 

• Look for tax-free opportunities. Interest from municipal bonds typically is exempt from federal income tax, and, in some cases, from state and local income tax, too. (Some municipal bonds, however, may be subject to the alternative minimum tax.) And if you qualify to contribute to a Roth IRA – eligibility is generally based on income – your earnings can be withdrawn tax-free, provided you’ve had your account for at least five years, and you don’t start taking withdrawals until you’re at least 59-1/2. Your employer may also offer a Roth 401(k), which can provide tax-free withdrawals. Keep in mind, though, that you contribute after-tax dollars to a Roth IRA and 401(k), unlike a traditional IRA and 401(k), in which your contributions are made with pre-tax dollars.

• Be a “buy and hold” investor. Your 401(k) and IRA are designed to be long-term investments, and you may face disincentives in the form of taxes and penalties if you tap into them before you reach 59 ½.  So, just by investing in these retirement accounts, you are essentially pursuing a “buy and hold” strategy. But you can follow this same strategy for investments held outside your IRA and 401(k). You can own some investments – stocks in particular – for decades without paying taxes on gains. And when you do sell them, you’ll only be taxed at the long-term capital gains rate, which may well be less than your ordinary income tax rate. But if you’re frequently buying and selling investments you’ve held for one year or less, you could rack up some pretty big tax bills, because you’ll likely be taxed at your ordinary income tax rate.

• Be prepared for unexpected taxes. Mutual fund managers are generally free to make whatever trades they choose. And when they do sell some investments, they can incur capital gains, which may be passed along to you. If this is a concern, you might look for funds that do less trading and bill themselves as tax efficient.

While taxes are one factor to consider when you invest, they should probably not be the driving force. You need to build a diversified portfolio that’s appropriate for your risk tolerance and time horizon. Not all the investments you select, and the moves you make with them, will necessarily be the most tax efficient, but by working with your financial and tax professionals, you can make choices that can help you move toward your long-term goals.

 

Edward Jones, its employees and financial advisors are not estate planners and cannot provide tax or legal advice. You should consult your estate-planning attorney or qualified tax advisor regarding your situation.

If you have questions about this article or other financial matters, contact Wilman at 301-690-8130 or email  wilman.cheung@edwardjones.com.

 

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