Financial Planning

4 Reasons to Tap into Your MetLife Leadership Deferred Compensation Plan Sooner Than Later

By Carmine Coppola

MetLife offers a lucrative benefits package; it’s one of the biggest advantages of working for the company. When it comes to retirement savings opportunities, especially, your available options are remarkably better than what the majority of employers offer. But many MetLife employees are unfamiliar with a plan that sets their benefits apart from most: the MetLife Leadership Deferred Compensation Plan.

This plan allows eligible employees at salary grades 10S to 13S, such as Assistant Vice Presidents and MetLife company officers, earning over $345,000 in total compensation for 2024 (determined by the IRS and may change yearly), to defer salary or bonus payments.

You’re probably already familiar with the 401(k), Personal Retirement Account (PRA), and traditional pension (for the tenured folks) and how they can benefit your financial well-being. The MetLife Leadership Deferred Compensation Plan is a lesser-known and far more flexible tool. It is a nonqualified deferred compensation plan (NQDC), also known as an elective deferral or supplemental executive retirement plan.

In this article we’ll give you a brief overview of how the plan works and then share four reasons why you need to begin utilizing it to your advantage, starting today.

What Makes the MetLife Leadership Deferred Compensation Plan Different?

There’s far more to this plan than you might think.

The MetLife Leadership Deferred Compensation Plan allows you to put away and invest an uncapped amount each year, reducing your taxable income by the amount you defer. You can also enjoy tax-deferred investment growth until distribution, with flexibility on when you start receiving distributions — at retirement or sooner if you want to align payouts with other earlier financial goals. And distributions are taxed at ordinary income tax rates, so imagine how you can use this strategically alongside your tax planning.

These deferred compensation plans also allow you to pick investments and can even qualify for a company match; consider this a raise! But unlike a 401(k) plan, a nonqualified deferred compensation plan places no limits on your contributions, no age restrictions on withdrawals, and no required minimum distributions.

So, how does this work?

How Deferments Work

MetLife permits you to defer your base salary, Annual Variable Incentive Compensation Plan or successor annual cash bonus plan or program (AVIP), sales incentive compensation, and/or performance shares. Minimum deferrals are 5% and max limits are 75% of your base salary with AVIP and Sales Incentive Performance Shares at 100%.

How the Company Match Works

Not only does participation allow for taking advantage of the tax benefit, but compensation deferrals are also eligible for company contributions through the MetLife Auxiliary Match Plan. The match is the same as the 401(k), with a maximum company match of 4% of compensation. For more details on the Auxiliary Match, you can visit our MetLife page where we give an overview of how that works.

How Distributions Work

When making contributions to the NQDC, you choose when and how distributions happen — meaning, you can tie distribution to a specific date or event, like a retirement date or layoff. And you also choose how the payment is received: lump sum or up to 15 annual installments. Again, distributions are taxed at ordinary income tax rates.

How Investing Works

NQDC contributions are not actually invested into funds in the way your 401(k) investments are. Instead, you choose which tracking funds to track and the plan balance will adjust according to the performance of those funds. MetLife currently offers 11 different tracking funds, each of which mirrors the performance of an index or actual fund. (Reference your guide to see what funds are available.)

Key Considerations in MetLife Leadership Deferred Compensation Planning

It’s gratifying to know you work for a solid employer who values your contributions and wants you to stick around. However, you have some critical decisions when you elect to participate in a deferred compensation plan. Participation typically involves adhering to a designated enrollment period and establishing a written agreement with MetLife.

This plan agreement outlines crucial details, such as the amount of income to be deferred, the deferral period or schedule of distributions, and your investment choices. Once elections are made, they can be difficult or impossible to change, so you don’t want to go into this lightly.

With so many possibilities and so much at stake, deferred comp plans can feel overly complex and even intimidating. The best way to start thinking about your strategic approach is to break it down into three main components:

What do you want to use the deferred compensation for?
How much of your salary or bonus will you defer each year?
When do distributions from the plan start, and how long do they last?

Before moving forward, understanding your options and looking at the big picture is vital

We will explore four situations in which you can confidently and strategically leverage your MetLife Leadership Deferred Compensation Plan.

Strategy 1: Tax Reduction

Deferrals into your MetLife Leadership Deferred Compensation Plan lower your taxable income in the year you defer income. So, if your total compensation was $400,000 and you decided to defer $25,000, your annual income would be $375,000.

A common strategy we use is offsetting other income, such as stock compensation or inherited IRA withdrawals, with deferred comp.

Let’s look at an example.

Gianna’s salary and bonus are $550,000 per year. She also receives stock compensation in the form of RSUs (restricted stock units), which, on average, is about $50,000 per year. RSUs are taxed as ordinary income when they vest, regardless of whether you sell the stock. She inherited an IRA from her father and is currently withdrawing $25,000 per year, which will continue for the next several years. This puts her total income at $625,000, placing her in the highest federal tax bracket. Keeping tax calculations simple for this example, Gianni would pay $187,636 in federal taxes. Making her effective tax rate 30.7%

Gianna does not need the additional $75,000 in income from the RSUs and IRA distribution, so she is losing a ton of money to taxes on income she will not be using right now. What can she do?

Because MetLife offers her a deferred compensation plan, she decides to defer $75,000 of her bonus each year. This will offset the amount she receives from the stock compensation and inherited IRA distributions.

Why would she do this? Look at the chart below.

As you can see, Gianna’s current plan puts her just over the threshold for the highest tax bracket. Deferring $75,000 of her compensation allows Gianna to reduce her taxable income to $550,000, keeping her just beneath the highest tax bracket. And her federal tax bill would be reduced to $160,690, saving her about $27,000 in federal taxes! This strategy allows her to maintain the same lifestyle spending, while the $75,000 she defers can be invested for retirement inside her NQDC plan.

If she continues this over the next ten years, that is an additional $750,000 in retirement savings, not including any investment growth. She can do this without spending any less or adjusting her lifestyle now. She’ll also realize the potential advantage of paying less in taxes because when she takes the distributions, she will be retired and in a lower tax bracket.

Strategy 2: Saving for Specific Goals

This strategy is simple and effective. All it takes is aligning your deferred compensation distributions with a specific goal in mind. This goal can be anything from your children’s education expenses to a down payment on a vacation home. Let’s look at how this concept works.

Bill and Laura have ambitious plans for their future. They want to make sure college expenses are covered for both children and purchase their dream vacation home. Their son will start college in eight years and their daughter in ten years, and they’d like to purchase their vacation home before the kids start college.

Cash flow is great for Bill and Laura right now. Bill has a deferred compensation plan through MetLife, and he developed a strategy to defer his salary over the next six years to fund the couple’s goals.

A common component of deferred compensation plans is the ability to have multiple accounts within the plan. Each account can have its own investment strategy and distribution schedule. When you make your elections, you decide which account you will be saving into. Bill’s plan at MetLife allows him to save into three different accounts inside his deferred comp plan.

As you can see from the chart, Bill created three accounts, each with a specific goal in mind. Account #1 will begin paying out in Year 8, over four years to pay for his son’s college. Account #2 will begin paying out in Year 10, over four years to pay for his daughter’s college. Account #3 will be paid out in a lump sum in Year 7 to cover the down payment on the vacation home.

Bill decides that deferring $50,000 per year into the accounts over the next six years will allow him to achieve his financial goals. Looking at the yellow boxes on the schedule, you can see that when distributions are made from the plan, they are each aligned with specific goals.

It’s important to note that we did not account for any investment growth in this example. This is something you should consider when determining if this strategy is right for you. Also, deferred compensation distributions are taxed as ordinary income, so being aware of what your total taxable income is likely to be at the time of distribution is also crucial.

Strategy 3: Filling the Income Gap until Social Security

If you decide that you want to retire “early” or before age 65, the question you might be asking is, “Where will my income come from?” Most people rely on Social Security to supplement their income in retirement. But how does that work if you retire earlier than you would like to begin drawing SSI or before you become eligible?

John and Sara are a married couple who are both 60 years old. They plan to retire when they are 62 and would like to wait until 67 to take Social Security. John has a pension that will start when he retires at age 62.

This is what their projected income looks like right now:

You can see that John and Sara will have an income gap of $60,000 for the five years before Social Security kicks in. They will have to pull this from retirement accounts or other investments, which can lead to depleting assets sooner than anticipated.

Let’s examine an alternate scenario in which Sara utilizes her deferred compensation plan through MetLife. In this example, Sara defers 50% of her yearly bonus until retirement. The deferred compensation plan is to be distributed over five years, starting when Sara reaches age 62.

This is what their projected income looks like using Sara’s MetLife Leadership Deferred Compensation Plan:

The gap they previously had to make up is now filled by Sara’s distributions from her deferred comp plan. This has a significantly positive impact on their future because now the couple can let their retirement and investment assets continue to grow over the five-year period and use those gains later to supplement their income.

It’s important to remember that a deferred compensation strategy like this needs to be reevaluated each year. There are a lot of moving parts to your plan; to stay on track, you need to adjust as needed constantly. For example, you may have some unexpected expenditures that affect your cash flow and may need more money in your paycheck instead of deferring that compensation later.

Strategy 4: Hedging for Getting Laid Off Early or Early Retirement

Let’s face it, companies go through layoffs and restructuring all the time. No employer, including MetLife, is immune to shifts in the economy, technological changes, or trends that lead to job losses. Unfortunately, the employees usually feel the most impact, especially the more highly compensated ones. Having a plan in place in the event you were to get laid off is essential to your financial well-being. The good news is if you have access to a deferred comp plan, it can be a great tool to hedge against uncertainty.

Let’s look at this in action. Mike has been a vice president at MetLife for the last ten years and is currently 55 years old. One of his major concerns is how an unexpected layoff would affect him and his family financially. To hedge against this possibility, he began deferring a portion of his bonus each year through his deferred comp plan. He set the distribution date as the day he separates or retires from the company, and the distributions will be paid out over five years. The current value of the plan is $350,000.

Looking at this chart, you can see that no matter when Mike leaves MetLife, he has a purpose for his deferred compensation. If he gets laid off at 58 (or any age, for that matter), the deferred comp will pay out over the next five years. Being that the current value is $350,000, that could be around $70,000 in income each year. This will allow him to buy some time while he looks for another job, or he could accept a job making less money since he has this income to supplement his pay.

In the second scenario, Mike retires early at 62. He would receive his payout over the next five years until he is 66. The deferred compensation income would supplement his other retirement income until he takes Social Security. It could also pay for health insurance since he most likely would not be covered under his employer’s plan, and Medicare does not start until he is 65.

The last scenario has Mike retiring at the end of the year he turns 65, the longest he would continue working. If he’s able to stay that long, Mike could then use the deferred compensation to supplement his retirement income. This would enable him to withdraw less from his retirement and investment assets, allowing them to continue growing. He can also defer Social Security until 70 to max out his benefit since the MetLife Leadership Deferred Compensation Plan payout would supplement his income in the meantime. The point is that Mike would have a lot of options and flexibility.

Important Caveats

It’s important to remember that all the potential benefits of the MetLife Leadership Deferred Compensation Plan come with some risks. It’s essentially an I.O.U. from MetLife; if they go bankrupt, your deferred compensation contribution is considered unsecured debt and could be lost. If a significant portion of your wealth is also held in stock options and restricted stock units, relying heavily on deferred compensation could mean too much of your financial well-being depends on MetLife’s financial strength. Moreover, effectively leveraging deferred compensation plans requires careful thought and planning.

Keep in mind that NQDC plans have been dubbed “golden handcuffs” for a reason. As a highly compensated employee, your work is a valuable asset to MetLife as an employer, so the benefit is designed to incentivize retention. The more you make, the more you pay in taxes, and the more appealing the tax shelter is. If you intend to stay with MetLife, the financial advantages of using the plan strategically can be substantial and potentially well worth the carefully measured risk.

Defer, Don’t Delay

Deferred compensation is a potent tool that necessitates a thoughtful approach. Carefully weigh your options and proceed with cautious enthusiasm — sooner rather than later. Don’t delay putting the plan to work for your future; remember, time is valuable.

Decisions regarding the MetLife Leadership Deferred Compensation Plan should be intricately woven into the fabric of your comprehensive financial and retirement plans. Given the complexity and stakes involved, we recommend collaborating closely with a seasoned financial advisor familiar with the plan to help navigate the myriad possibilities and make informed choices aligned with your long-term goals.

As specialists in MetLife benefits and executive wealth planning, we offer a complimentary consultation to answer your deferred compensation questions. You can schedule a free session with our team here.

Strata Capital is a wealth management firm serving corporate executives, professionals, and entrepreneurs in the New York Tri-State Area, focusing on corporate benefits and executive compensation. Co-founded by David D’Albero and Carmine Coppola, the firm specializes in making the complex simple to ensure clients feel confident in their financial decisions. They can be reached by phone at (212) 367-2855, via email at carmine@stratacapital.co, or by visiting their website at stratacapital.co.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

This represents the views and opinions of Strata Capital and has not been reviewed or endorsed by MetLife or any of its employees. MetLife is not affiliated with Strata Capital and has not endorsed or approved their services.

This material was prepared by Crystal Marketing Solutions, LLC, and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate and is intended merely for educational purposes, not as advice.

Practical and Creative College Funding Strategies | Strata Capital

Is your child’s college savings on track? In this video, Carmine Coppola sheds light on practical solutions for parents saving for their children’s college education. He explores various strategies for effectively managing college funds, including utilizing existing assets, family contributions, and student loans.

Topics Discussed:

Determining if current educational savings are adequate
Other assets to consider putting towards college savings
Family contributions to college fund
Student loans as a last resort

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The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

The information contained above is for illustrative, educational, and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.

Cornerstone Planning Group, Inc., (“CSPG”) is an SEC registered investment advisory firm. The information contained herein should not be construed as personalized investment advice and should not be considered as a solicitation for investment advisory service. The information (e.g., tax ) provided is believed to be accurate however CSPG does not guarantee or otherwise warrant such information. For more information regarding CSPG you can refer to the Investment Adviser Public Disclosure website (www.adviserinfo.sec.gov) and review our Form ADV Brochure and other disclosures.

Easing Financial Worries: Strategies for Stressing Less about Money

By Carmine Coppola

Money can be a real stressor for many of us, especially when juggling multiple responsibilities. The worries around finances, including income, debts, savings, and managing expenses, can take a toll on our mental and physical well-being. Whether it’s dealing with economic uncertainties, job insecurities, or balancing various financial obligations, it’s quite the load to carry.

The good news? You’re not alone in this, and practical ways exist to ease this stress. Let’s explore some strategies together that can truly make a difference.

Get Organized

Understanding your current financial situation is like having a roadmap to navigate through the stress. Take some time to gather information about your income sources, debts, expenses, savings, investments, and retirement plans. Simplify it by jotting down where your accounts are, what types they are (like individual or 401(k)), and who manages them. This simple step can provide a clearer picture of where you stand financially.

Tackle Debt

Debt can be overwhelming, but breaking it down can make it more manageable. For those revolving credit card debts, noting each card’s interest rate and minimum payment can be an eye-opener. If you want to take advantage of one of the common solutions for attacking revolving debt, consider taking out a consolidation loan or a balance transfer. The consolidation can work if the interest rate is lower than the current weighted rate and the payment is the same or less. If you go with a balance transfer, make sure you devise a plan to pay off the debt before interest is due. Designing a pay schedule is the best way to implement this.

Listing balances, interest rates, and payments is a smart move for installment debts like mortgages or car loans. Exploring consolidation or calculating how extra payments could shrink those balances faster might be beneficial. For this type of debt, you can also shop it out to see if it makes sense to consolidate everything, or maybe a portion of it, for a lower interest rate. You can even run calculations to see how quickly extra payments would pay down your balances.

Remember, paying off debt takes time, so patience is key here.

Create a Budget Based on Cash Flow

At the core of any financial plan lies understanding your cash flow – what comes in and what goes out. Conducting a cash flow analysis can shed light on your monthly income and expenses. By prioritizing needs like mortgage, utilities, and food and balancing them against debt payments, you’ll get a clearer idea of how much extra you have for paying down debt, starting an emergency fund, or saving for retirement and other needs.

Creating a budget based on this information and sticking to it can significantly reduce stress. It’s not about restricting yourself but being responsible with what you have. Working with actual dollars rather than wishful thinking can make all the difference on the path to financial independence.

Simplify. Simplify. Simplify.

Sometimes, we can overly complicate our financial situations, leading to bad habits or bad financial decisions. We are firm believers in less is more. Here are some steps that can help you nurture healthier financial habits:

Simplify Credit Cards

Ever found yourself juggling multiple credit cards for various purposes? After implementing the steps to manage your debts, it’s time to get specific about which card serves what purpose. Maybe one for everyday expenses, another for travel, and one dedicated to shopping? Assigning purposes makes tracking expenses easier, and, remember, the golden rule is always to pay the balance before the interest clock starts ticking.

Simplify Investment Accounts

Maintaining a unified investment strategy demands dedication and effort. Why make it harder by scattering your investment strategy across various accounts? Consider this scenario: when leaving a job, many individuals leave their 401(k) behind. Fast forward a decade, and you might find yourself managing three separate 401(k) accounts. Updating your investments then means juggling between three different places. Work with a financial advisory firm, such as Strata Capital, to strategically streamline and consolidate these accounts to simplify management and potentially reduce associated fees.

Simplify Bank Accounts

Let’s circle back to our cash flow discussion. Too many bank accounts can add unnecessary confusion to bill payments and expense tracking. Simplify your accounts with intention. Consider a spending account for day-to-day expenses, a separate one for bills, and another for savings. This clear division helps you stay on top of your financial game.

Start Building Wealth

Once you’ve taken strides to reduce debt or organize your spending, it’s time to step into the world of wealth building. Building wealth isn’t just about buying luxurious items; it’s about fostering a sense of security and confidence in your financial future. Begin by establishing an emergency reserve account to use as a safety cushion against unforeseen financial hurdles.

Remember, building wealth is a long-term game that requires commitment and action. Your future self will appreciate the steps you take today. It’s crucial to act decisively and set your plans into motion. These strategies aim to offer a brighter outlook on financial management, empowering you to seize control of your financial well-being!

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

The Real Cost of Dipping into Your 401(k) Early

If you’ve ever considered pulling money out of your 401(k) prematurely to cover more immediate financial needs or desires, you’re not alone. Individuals often find themselves contemplating early withdrawals as a quick solution, with the allure of immediate access to funds overshadowing longer-term concerns. But while tapping into your retirement accounts may seem like a convenience worth using to your advantage, ease of access frequently clouds judgment when it comes to the true cost.

What if you’re decades away from retirement and your career is progressing well, but you’re still renting and want to buy your first home? Using the money stashed in your 401(k) toward a downpayment can be tempting, but is this a sound choice? Maybe you’ve dreamed of starting your own business and have the skills to succeed; would bootstrapping with your 401(k) be a good idea? Or perhaps you’ve been laid off, your industry is in a lull, and your kids’ private school tuition is due soon. Should you turn to your 401(k)?

The answer is that it depends. Prematurely drawing on your 401(k) comes with fees, taxes, and the potential for significant gains to be lost over time.

Our aim is not to dissuade you outright, as it may be the most suitable course of action in your situation, but rather to provide clear insight into the potential financial impact of early 401(k) withdrawal. We encourage you to carefully analyze the numbers and assess your situation against the full range of implications for your retirement future.

By looking at the bigger picture and exploring possible alternatives, you can make an informed choice with confidence and foresight.

Real-World Dilema: Should Ben and Kate Tap into His 401(k) to Buy a Home?

Let’s explore a scenario that’s become increasingly common in the midst of soaring home prices and mortgage interest rates. Even homebuyers who have carefully planned and saved diligently may find themselves scrambling to bring more money than expected to the table to get the deal closed. Is overcoming this obstacle worth making an early 401(k) withdrawal?

Ben and Kate are 30 years old, newly married, and are in the process of buying a home. The market is competitive, so it turns out that they will need an additional $50,000 for a down payment and other closing costs. Beyond what they’ve already earmarked for the home purchase, their cash reserves have run dry, so they look to Ben’s 401(k). The balance is currently $125,000.

For Ben and Kate to net the $50,000 needed, they need to withdraw $72,000 from Ben’s 401(k). This is to account for a 10% premature withdrawal penalty ($7,200) and 20% in taxes ($14,400). 72,000 – 7,200 – 14,400 = $50,400. This penalty applies to those withdrawing from a retirement account (401(k), IRA, etc.) prior to reaching age 59 ½. While there are some exceptions, it’s important to consult with a financial advisor before making any withdrawals.

So you may be thinking, ‘Yes, it is unfortunate that they have to pull out more money to account for taxes and penalties. But in the grand scheme of things, it’s not that much. It’s better than continuing to rent, right?’ That is, until you start to consider the future value of the $72,000 withdrawal. Let’s walk through two scenarios to show you what this looks like.

In Scenario #1, represented by the green line, Ben and Kate decide not to pull the extra funds from Ben’s 401(k). In Scenario #2, Ben and Kate withdraw $72,000 from Ben’s 401(k) to cover the down payment. In both cases, the 401(k) has an annual average rate of return of 6.5%.

You can see the power of compounding returns in the graph. Scenario #1 has Ben’s 401(k) balance at over $1.1 million when he’s 65. But in Scenario #2, the account balance at 65 is just over $480,000.

The difference is a whopping $652,482!

By looking at the numbers, you can see that Ben’s $72,000 withdrawal can potentially become a $652,000 cost to his and Kate’s future. This is a number that can greatly impact when they retire and what kind of lifestyle they have in retirement.

Sometimes you have no choice but to withdraw from your retirement accounts, and that’s okay. If pulling the money out now offers the boost you need that allows you to raise your family in a great neighborhood, you might consider it a no-brainer. And if the alternative to using this available resource is foreclosure following an unexpected stretch of unemployment or foregoing an expensive medical treatment that’s not covered by insurance, your future retirement may not be your top priority.

However, in every situation, it is extremely important to understand how these decisions impact your long-term financial goals. Understanding the impact on your future self may sway your decision-making when considering a large premature 401(k) withdrawal.

Alternatives to Withdrawing Funds from Your 401(k)

Taxable Investment Accounts: There are no penalties for pulling money out of your brokerage account. One thing to look at is the unrealized gain on your positions. If you’ve held your positions for over a year, then you would pay long-term capital gains tax on the gains only, which is typically less than ordinary income tax.
Securities Backed Line of Credit (SBLOC): Let’s say you have a brokerage account but don’t want to sell your investments. Taking a line of credit against your investments could be a good alternative solution. Of course, you have to repay this loan, making it an added monthly expense, but this option usually works best as a short-term solution. For example, say that Kate had a $50,000 net bonus being paid out in 4 months. Taking out an SBLOC for the down payment and then using the bonus to pay off the line of credit could be a good option.
Borrowing from Family or “Early Inheritance”: Not everyone has this option, but for those who do, it can save you a ton of money. If you have a family member that you know is leaving you money when they pass, showing them the numbers we went through in the article may motivate them to give you some of your inheritance early.

The path you take depends on your specific finances and resources. You’re more likely to miss opportunities if you assume there’s only one way to go and allow your judgment to be clouded by emotions. Making rash moves can be costly.

Should You Tap into Your 401(k) Early?

The decision to withdraw funds from your 401(k) should never be taken lightly. By understanding the true cost of early withdrawals, including the fees, taxes, and long-term impact, you gain the power to make an informed choice. Rather than heedlessly opting for the easy solution, take the time to assess your needs, weigh the potential losses against gains, and explore alternatives. Remember, your 401(k) is a valuable tool in securing your financial future.

At Strata Capital, we specialize in providing insightful financial analysis and guidance to help you make well-informed choices that align with your long-term goals. Our team can run the numbers, assess the impact on your financial future, and work with you to explore alternatives that may be more favorable. We welcome the opportunity to provide you with financial direction to help you live your best life. Feel free to schedule your consultation here.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Strategic Cash Flow Planning: Make Your Money Work

Have short-term financial goals like vacations, tuition, or a home renovation? Keep your money from sitting idle in low-yield checking or savings accounts. In this video, Carmine Coppola explores the concept of strategic cash flow planning, a method that aims to optimize returns for short-term financial needs.

Strategic Cash Flow Planning: Make Your Money Work from Strata Capital on Vimeo.

Topics Discussed:

Short-term financial goals
Investment options for short-term needs
Real-world example

Transcript:

Today I want to touch up on a topic I like to call “strategic cash flow planning.” Essentially what that is, is it’s taking money you have set aside for your short-term financial goals such as tuition payments, vacation, or even maybe buying a boat, and maximizing return by taking little to no risk at all. Let me show you how we do that.

Look at Frank’s cash flow he needs for the next year. He has a family vacation in December, college tuition due in January, a new car in February, a big home renovation he plans on doing in March. He has his daughter’s wedding he needs to pay for an April, and new furniture for that renovated house in May. And in July he needs $100,000 for a private investment opportunity. All this totals to $570,000. Here’s what we can do to be strategic with Frank’s cash flow stream.

The first thing we need to do is decide on which investment vehicle to use. For Frank, we’re going to stick with US Treasuries because his cash flow needs are under one year. Other options may be CDs, money markets, or even structured products. Here’s a cash flow portfolio we designed for Frank. We set this up so the correct amount of money comes due when Frank needs it for a specific cash flow need. We do this in order to maximize the return on the entire portfolio. You’ll see here that for this portfolio, the yield is just over 5.4%. The total money that he’s going to invest will be about $570,000.

Here’s what the portfolio’s cash flow will look like over the next year. You’ll see that each Treasury will mature in the month that the money is needed. If you look closely, you’ll notice that the money coming due is slightly higher than the amount that Frank needed. For example, he said he needed $250,000 for his home renovation. When that Treasury matures in March he receives just over $258,000. Looks like Frank can splurge on those countertops after all.

The total amount of money that he’ll receive over the next year on this portfolio will be $589,881. If you recall, Frank said that he needed about $570,000 to fund his short-term goals over the next year. By being strategic in his cash flow and investing that $570,000 into this cash management portfolio, he was able to get back over the next year $589,881. So he’s able to gain almost an additional $19,000 for money that would have been sitting in a checking or savings account anyway. That’s how being strategic with your cash flow can really benefit you.

If you have money sitting in the bank or under your mattress, it’s really advisable to look into something like this just to maximize your return or even put in less money to achieve your goals. So if you guys have any questions, let us know. We’re here to help.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

The information contained above is for illustrative, educational, and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.

Selling Your Home? Don’t Get Blindsided by Capital Gains Tax

Over the past few years, property values have soared. Homeowners around the country and in the most desirable New York Tri-State areas have experienced the thrill of competitive offers. Even if you had no plans to sell, watching your neighbors cash in, checking Zillow, or fielding unsolicited inquiries from aggressive buyers and agents may have piqued your interest.

But a word of caution: the excitement of navigating a real estate market in an era where homes fetch record prices can leave you vulnerable to emotional whims. While it’s possible that selling your home could be a lucrative opportunity, it’s prudent to consider every potential drawback before making a move.

When sellers are eager to access the proceeds of substantial equity returns, there’s one big ‘gotcha’ in particular that often escapes their attention: capital gains tax. The exhilaration of a high-value sale is undeniable, but don’t forget that the IRS will expect their share. You may be thinking, ‘So what if I have to give up a percentage of a windfall I wasn’t expecting?’ But knowing the rules and planning for them means you may be able to avoid paying more than necessary.

While the potential of paying capital gains tax shouldn’t prevent you from selling your home, it would be smart to become familiar with its intricacies. If you empower yourself with the knowledge of what to expect, you may be able to save some money and leverage your financial wins to your benefit.

Here’s what you should know to avoid being blindsided by an unexpected tax bill.

What Are Capital Gains Taxes?

Capital gains taxes are the taxes you must pay on the income you make from profit on an investment. If you sell your house for more than you paid, you can guarantee the IRS will want a cut. But the amount due depends on more than a simple calculation; it depends on your taxable income, filing status, and how long you owned the home (or other investment) before selling it.

To further complicate matters, every capital gains scenario is different.

Short-term capital gains, applicable if you held the property for a year or less, mirror your regular income tax rate and are dictated by your tax bracket. In this case, if possible, the ideal strategic move would be to sidestep short-term gains.

Long-term capital gains, on the other hand, offer more favorable taxation. Owning the property for over a year qualifies you to pay the long-term capital gains rate of 0%, 15%, or 20%, depending on your income and filing status.

It’s also important to note that in addition to capital gains tax, you may also have to pay state income tax on the profits, depending on your state’s tax laws.

Do You Qualify for a Capital Gains Exclusion?

Thanks to specific IRS exclusions, you can sometimes avoid excessive capital gains tax when selling your main residence. If you’re single, you can exclude up to $250,000 of capital gains from your taxes when selling a home. For married couples filing jointly, this exclusion doubles to $500,000. Keep in mind, though, that you can only use this exemption once every two years.

Understanding and leveraging capital gain exclusions can significantly boost the financial rewards of selling your property. It’s a tax-saving strategy that allows you to pocket a significant portion of your home sale profits without excessive burden.

Unfortunately, the exclusion doesn’t apply to every situation.

Unlocking the capital gains exclusion hinges on meeting all of these requirements:

First and foremost, your house must have been your primary residence.
You owned the property for more than two years
You lived in the home for at least two years in the five-year period before the property is sold
The property wasn’t obtained through a 1031 exchange (i.e., ‘like-kind exchange’) transaction.
In the past two years, you haven’t utilized the capital gains exclusion for any other residential property.

Familiarizing yourself with these qualifiers is essential, as they delineate the scope of the exclusion and influence your ability to leverage its benefits during the sale of your property.

Understanding Capital Gains Scenarios

To help you better understand how various capital gains situations can play out, here are a few “real-life” examples. These stories showcase how a nuanced understanding of these intricacies can wield remarkable financial impacts on each seller’s life.

Scenario #1: Small Business Owner Avoids Capital Gains After Renting Out Her Condo

Courtney, who owns a successful small business, purchases a new condo for $300,000. She lives in it for a year and decides that she would like to move to a different neighborhood. Instead of selling her condo, she finds a couple to rent it. After three years, the couple moves out, and Courtney returns to her condo. She lives there for another year and decides to sell it. She sells it for $500,000 – a $200,000 profit. Because Courtney lived in the condo as her primary residence in two out of the last five years, and the profit did not exceed the $250,000 exclusion amount, no capital gains tax is due.

Let’s consider an alternate ending to Courtney’s story. Instead of moving back in after the tenants move out, Courtney decides to sell. At this point, she would have owned the condo for four years but only lived in it as her primary residence for one year. Because she did not meet all the exclusion requirements, but did at least own the home for over one year, she would have to pay long-term capital gains on her $200,000 profit. Depending on her tax bracket, this would cost her between $10,000 and $40,000—cash that she could have kept if she had lived in the home for one more year before selling.

Scenario #2: Grandparents’ Exclusion Nets 35% Tax Savings

Mario and Lisa are an older couple who have lived in their home for over 40 years. The neighborhood has changed dramatically, and they want to be closer to their children and grandchildren, so they decide to sell. They originally purchased their home for $80,000, now worth $1,500,000.

The total profit on the home sale is $1,420,000. As a married couple who files their taxes jointly, they qualify for the $500,000 exclusion. They will owe long-term capital gains only on $920,000 ($1,420,000 – $500,000), a more than 35% savings.

Scenario #3: Married Couple Makes a Costly and Preventable Capital Gains Misstep

Joseph and Olive are a young married couple living in the city and making a good living. During the pandemic, they decided they wanted to get out of the city for more space. They end up selling their condo, which they purchased for $300,000 five years ago, for $600,000. They do not owe any capital gains tax because the profit of $300,000 is under the $500,000 exclusion threshold. They find a home in the suburbs near the city for $550,000.

After nine months of living in their new home, they realize that the suburbs aren’t for them and want to return to the city. Because their neighborhood is so desirable, they are told they can sell their home for $700,000, $150,000 more than they paid less than a year ago. They decide to list, and the house sells almost immediately. Joseph and Olive think that no taxes will be owed because they lived in it, AND their profit is under the $500,000 threshold.

However, they cannot use the exclusion on this sale because they used it on the condo within the last two years. Not only that, they also owned the property for under one year, so they will have to pay short-term capital gains instead of long-term. The $150,000 will be taxed at their ordinary income tax rate on top of their other joint income of $300,000. Adding the $150,000 to their joint income would place them in the 28% federal tax bracket, meaning they would owe about $42,000 in taxes on their profits.

Let’s look at some alternatives Joseph and Olive could have taken. For starters, if they waited just three months to sell the home, they would have paid long-term capital gains rates (15%) on the $150,000 profit for a tax of “only” $22,500. This alone would have saved them $19,500 over the short-term capital gains tax.

If they could wait an additional 15 months to sell the home, they would have qualified for the exclusion again and paid no capital gains tax.

Of course, neither of these alternatives take into consideration whether the real estate market would have allowed them to sell their home for the same amount months later, but having all the facts about capital gains taxes can only help when deciding if and when to sell.

Scenario #4: Savvy Real Estate Investor Carefully Considers His Options

Jon is a contractor who flips houses on the side. He finds a great deal on a property in an up-and-coming neighborhood. He purchases the property for $350,000 and puts about $100,000 of work into it over six months. The property is now valued at $700,000; this would mean a profit of $250,000 ($700,000 – $450,000). Here are two possible outcomes for Jon’s sale:

Ending A: Jon sells the property for $700,000 and owes short-term capital gains on the $250,000 profit. He does not qualify for any exclusion because it is an investment property.

Ending B: Jon finds a tenant to rent the property for a year. The rent he receives covers his monthly costs (mortgage, taxes, etc.). After the tenant moves out, Jon would have owned the property for 18 months. He would now pay long-term capital gains on the profit of $250,000. Jon may also have the opportunity to utilize a 1031 exchange and invest the proceeds of this sale into another like-kind property without paying capital gains tax, thus deferring the taxes to a later date.

(A 1031 exchange is a swap of one real estate investment for another that allows for capital gains to be deferred. There are certain rules and requirements that one must meet to qualify, including owning the property for at least one year, so it is best to discuss this with your tax, financial and legal advisors prior to engaging in this type of transaction.)

By holding the property just a little longer, Jon can save thousands of dollars in capital gains taxes. He also may be able to defer taxes further. As with our young married couple, Jon also needs to consider whether he could still sell for $700,000 if he waits another year or if it makes more sense to sell while the market is hot.

Scenario #5: Advanced Tax Savings Strategy for Sophisticated Investors

James and Keith are a wealthy couple with many different investments in their portfolio. They own several investment properties and would like to sell one that they can get a great price on due to rezoning in the area. They sell the property and make a profit of $500,000. Since these are investment properties, the exclusion does not apply, so they will pay long-term capital gains on the profit.

However, since the stock market is having a rough year, they look at their stock portfolio and notice a large unrealized loss of $400,000 in one of their stocks. They sell the stock, take a long-term loss of $400,000, and reinvest the proceeds into a different stock within the same industry inside their portfolio.

Now, here is where it gets fun. They can use the $400,000 loss to offset the $500,000 gain from the property sale, meaning they have a net capital gain of $100,000! So now they owe long-term capital gains on $100,000 instead of $500,000.

Additional Capital Gains Strategies to Consider

All of this may seem overwhelming, but you don’t have to memorize the details; you simply must know every action must be carefully considered. Don’t underestimate the nuances of capital gains and all the varied possible outcomes. Before parting with a property that has appreciated, it’s imperative to factor in all relevant considerations.

One often underestimated strategy to reduce capital gains is elevating your home’s cost basis through documented home improvements and repairs.

By boosting your recorded costs, you reduce your profit and minimize the capital gains tax liability. Consider Mario and Lisa’s scenario from earlier. Had they diligently tracked receipts for their home’s upkeep and enhancements over the past four decades, they could have augmented their cost basis by a substantial $200,000, significantly mitigating their tax liability upon sale.

Another essential presale exercise, particularly for those in their later years, is contemplating your legacy.

Analyze your asset portfolio to determine what you’ll pass down to your heirs. In the realm of taxation, real estate can be a valuable asset to bequeath. The reason lies in the step-up in cost basis that heirs receive upon inheriting the property.

Again, think of Mario and Lisa. What if they opted not to sell their home, choosing instead to leave it to their children? Upon their death, the home’s fair market value is appraised at $1,500,000. When their children eventually sell it for the same amount, they owe zero capital gains tax because there’s been no profit in their possession ($1,500,000 cost basis – $1,500,000 sale = $0). This is because the children will receive a step up in cost basis when they inherit the home after their parents pass.

Learn the Rules and Play with Caution

Understanding the dynamics of capital gains can be a game-changer. Capital gains tax rules can have a substantial impact on your wealth management. A comprehensive grasp of the intricacies empowers confident and strategic navigation of real estate transactions. Exploring various options, implementing tax savings strategies, and avoiding costly mistakes can make a significant difference.

When it comes to making complex financial decisions, it’s crucial it is to have expert guidance. That’s why we encourage you to seek the insights and support of our experienced financial planners and other qualified professionals like CPAs and tax and estate attorneys. Let us be your compass, guiding you on a successful and informed financial journey. Contact Strata Capital today, and let us help make your complex decisions simple.

Cornerstone Planning Group, Inc., (“CSPG”) is an SEC-registered investment advisory firm. The information contained herein should not be construed as personalized investment advice and should not be considered as a solicitation for investment advisory service. The information (e.g., tax ) provided is believed to be accurate however CSPG does not guarantee or otherwise warrant such information. For more information regarding CSPG you can refer to the Investment Adviser Public Disclosure website (www.adviserinfo.sec.gov) and review our Form ADV Brochure and other disclosures.