By Kevin Estes

Q&A Session

T-Mobile employees asked many good questions in a recent Question & Answer session!

Some of those questions were:

• Does it make sense to contribute to a 529 now that my kid’s in high school?

• I moved for work. Should I sell my old home?

• Would a Roth conversion after retirement lower my taxes?

• Instead of keeping your 401(k) until you are 59 1/2, should you take some early?

• When you take 401(k) distributions before you reach retirement age, is there still a penalty?

• How do we make the most out of our rental property?

• What are best practices for us renting it or using a property management company?

• Do you have best practices for how to treat the extra cash, $1,500 a month?

• We have been married for 10 years and have not joined our finances. Is that recommended?

• Would I be taxed like crazy if I sell my stock?

Below are some quick thoughts. None of them include any financial, tax, or legal advice.

Does it make sense to contribute to a 529 now that my kid’s in high school?

Maybe!

It could make sense if there’s an income tax deduction. Because there isn’t an income tax in Washington state, there’s no 529 deduction. The tax benefit depends on the state.

Funds in a 529 plan grow tax-deferred. If they’re used for qualified education expenses, the growth is tax-free. Thanks to the Tax Cuts and Jobs Act (TCJA), funds in a 529 can also be used for K-12 education.

Someone might even earn tax-free growth if they contribute when their child is in college! 529 funds can also be used for graduate school.

However, it depends on the situation. The value of a 529 will be assessed as an asset for financial aid. Also, someone may have better uses for those funds.

I moved for work. Should I sell my old home?

It depends. Below are some considerations.

Sell

There are several benefits of selling the home right away!

Relocation Package
If someone relocated for their employer, some of the costs may be reimbursed by the company through a relocation package. Holding onto the home might lose those benefits.

Home Gain Exclusion
Another big benefit of selling is that someone may be able to take advantage of the home sale exclusion.

Someone could avoid paying federal taxes on the gain if they sell their home, up to:

• $250,000 for the Single filing status

• $500,000 for the Married, Filing Jointly filing status

The primary requirements are to have:

1. owned and

2. lived in the home two of the last five years.

These 24 months need not be consecutive, which leads to some additional planning opportunities.

Frees Up Cash Flow
Selling will likely free up a fair bit of cash which can be used for other investments or living expenses. If someone has better other investment opportunities, it may make sense to sell.

Eliminating the mortgage, maintenance, utilities, and other ongoing expenses lowers monthly expenses. Repairs in particular tend to be large and unpredictable. Selling could also cut the transportation costs to check in on the old home.

Keep

The biggest benefit of keeping the previous home would be to turn it into a rental. It’s worth considering.

Takes Time
Managing real estate is a part-time job! Even if someone hires a property manager, they’ll still need to make decisions on major home repairs and renovations.

Low Fixed Interest Rate
Many people who purchased their home a few years ago have a fixed mortgage with a low interest rate. It’s hard to walk away from a 30-year fixed loan at 2-3%!

A low interest rate makes it more likely that the property will cash flow - especially since rents have risen. Regardless of someone’s expenses, it’s important to charge market rent.

Profit Growth
In addition, profits tends to rise with rentals because:

• mortgage interest expense falls as the loan is paid off and

• rents tend to rise with inflation.

Many people look at the rent they could receive and subtract their mortgage. However, there are many other considerations such as:

• occupancy - properties are rarely rented 100% of the time

• maintenance - perhaps 1% of the value of the home each year

• HOA dues - Home Owner Association fees vary greatly

• property taxes - are usually included in the mortgage

• utilities - rising costs need to be passed onto the tenant(s)

• property management fees - depend on the market

Depreciation may lower taxable income for the property. However, it often doesn’t lower someone’s earned income from their job(s).

If a property is consistently cash flow negative, it can impact the owner’s ability to achieve their financial goals. I sometimes wonder whether a home is an investment.

Owning one (or more) homes seems more like a lifestyle decision. A rental is different.

Would a Roth conversion after retirement lower my taxes?

Maybe.

People often think of taxes as a once a year activity. They consistently try to lower annual taxes.

I like to think about taxes over someone’s lifetime. Someone may be able to lower their lifetime taxes by:

• lowering income in high-income years and

• raising it in low-income year.

Lower Income in High-Income Years
Many people are already their lowering income in high-income years with contributions to their:

• 401(k),

• spousal IRA,

• Health Savings Account,

• Donor Advised Fund,

• favorite charity…

Required Minimum Distributions
If someone saves more than they’ll need in their pre-tax (traditional) retirement accounts, they may have to pay Required Minimum Distributions (RMDs) later in life.

The federal government essentially gets impatient. It:

• gave a tax break when the funds were contributed and

• let it grow tax-deferred.

The government wants someone to realize that income and pay the taxes during their lifetime so it forces older Americans to withdraw a certain amount from their traditional retirement accounts each year. The percentage someone must withdraw rises with age.

Those distributions can spike income later in life and require someone to pay a higher tax rate.

Roth Conversions
One option to head that off is to roll a traditional account such as a 401(k) or an IRA into a Roth IRA.

Doing so increases taxable income for the year. However, it may not be taxed as much as it would be later with Required Minimum Distributions.

Because Roth accounts are after-tax, the government’s already received income taxes! There generally aren’t RMDs on after-tax retirement accounts.

Doing strategic Roth conversions may lower lifetime taxes and simplify finances at advanced ages.

Cash Flow Negative
One drawback to a Roth conversion is that the funds don’t go to the individual. Quite the opposite!

Someone doing a Roth conversion has to pay the tax out of pocket to convert the funds from traditional to Roth.

Financial Aid and IRMAA
Also, the timing matters. A Roth conversion two years prior to when a child starts college could reduce financial aid.

The same goes for two years before someone goes on Medicare as early as age 65. Higher income could result in someone paying higher premiums for:

• Part B and

• Part D.

This is called their Income-Related Monthly Adjustment Amount (IRMAA) and complicates the Roth conversion decision.

Instead of keeping your 401(k) until you are 59 1/2, should you take some early?

Probably not.

A Roth conversion is different from a distribution:

• A Roth conversion changes it from pre-tax to after-tax.

• A distibution withdraws funds from the account.

While there are some unique situations when it may make sense to withdraw funds from a 401(k) before age 59 1/2, it’s important to carefully consider the decision. Withdrawals could be subject both to regular income tax and a penalty. The funds may also lose some creditor protections.

When you take 401(k) distributions before you reach retirement age, is there a penalty?

Yes, usually.

Someone distributing funds before age 59 1/2 must normally pay income taxes plus a 10% penalty.

However, there are many exceptions including:

• total and permanent disability,

• qualified higher education expenses,

• separation from service the year an employee reaches age 55
  (age 50 if a public safety employee), and

• a series of substantially equal payments.

How do we make the most out of our rental property?

It’s important to treat a rental like a business.

It may make sense to:

• place the company in an LLC for additional protection,

• use a dedicated checking account to simplify accounting, and

• get umbrella insurance for additional personal protection.

Consider All Costs
Before deciding to rent, model the expected revenues and expenses. Include assumptions for:

• occupancy,

• interest expenses,

• property taxes,

• maintenance,

• Home Owner Association (HOA) fees,

• homeowners insurance (including a rental endorsement),

• property management fees…

Define Roles and Responsibilities
It’s also important to determine who’s going to do what:

• Who will advertise and show the property?

• Who’ll select the tenants - and on what basis?

• Who will receive the 2am call when a pipe bursts?

• Who’s going to call the plumber/electrician/repair person?

• Who’s going to buy and take space heaters over to the rental if the furnace fails?

What are best practices for us renting it or using a property management company?

There are basically two options:

1. manage the logistics yourself or

2. hire a property manager.

The choice could depend on:

• available time - someone with little free time may need to hire

• skill - it’s tough to rent without experience

• rental location - the further away, the tougher it is to self-manage

• rent - higher rents may require a higher level of service

• resources - it may be tough to hire a manager with limited cash flow

Do you have best practices for how to treat the extra cash flow, $1,500 a month?

First, I’d double-check that $1,500 a month:

• Does it include all expenses?

• Is there a haircut for lost rent after a renter moves?

• How would replacing the roof or furnace be funded?

Then, consider other major opportunities:

• Could higher deductibles lower insurance premiums?

• What about paying premiums a year or six months in advance?

• Is the emergency/opportunity fund large enough to pay for all deductibles if they hit at once?

• Would it cover at least three to six months of living expenses, including the rental?

• Is someone receiving the full employer retirement match?

• What about contributing to their Health Savings Account?

• How about the Employee Stock Purchase Plan?

• Would it make sense to contribute to a Spousal IRA?

• What about contributing to an after-tax account?

We have been married for 10 years and have not joined our finances. Is that recommended?

Thank you for sharing. That decision is deeply personal.

Many people think of combining finances like a light switch: on or off. However, I view it like a dimmer switch with infinite possibilities.

The most important thing is to do what works for you as a couple!

For more, check out: Combining Finances Is Like a Dimmer Switch.

Would I be taxed like crazy if I sell my stock?

It might be taxed less than you think!

It depends on:

• how you came by the stock,

• how long you’ve owned it, and

• what it’s done since.

Regular Purchase
Let’s say someone paid cash for a stock on the open market.

Good news! It rose in price. The owner realizes the gain by selling.

Short-Term Capital Gains
If the stock was held a year or less before it was sold, the gain will usually be taxed as a short-term capital gain. It would be taxed at their ordinary income marginal tax rate.

Long-Term Capital Gains
If the stock was held more than a year before it was sold, the gain will typically be taxed as a long-term capital gain. That means it will be taxed at the lower capital gains rates of:

• 0% for those with lower income,

• 15% for those with moderate income, or

• 20% for those with higher income.

Net Investment Income Tax (NIIT)
An additional 3.8% tax may apply. This tax helps fund Medicare.

It applies to someone who earns at least:

• $200,000 as a Single filer or

• $250,000 for Married, Filing Jointly.

This is yet another reason lowering income in high-income years could lower lifetime taxes.

RSUs
When Restricted Stock Units (RSUs) vest, some shares are typically sold to fund federal and state taxes. The remaining shares deposited in someone’s account have already been taxed!

If someone holds onto those shares, it’s like they took money out of their checking account to buy it at the market price when the units vested.

Is that what they would do?

Short-Term
Selling a year or less after the vest would result in:

• a short-term gain,

• no gain or loss (rare), or

• a short-term loss.

Long-Term
Selling over a year after the vest would result in:

• a long-term gain,

• no gain or loss (rare), or

• a long-term loss.

For more, check out: How Are Restricted Stock Units Taxed?

Employee Stock Purchase Plan (ESPP)
Shares purchased through an Employee Stock Purchase Plan (ESPP) have another requirement. In addition to owning the stock for at least a year after purchase, it also has to be held for at least two years after the start of the offering period.

The offering period is the time between when the employee started contributing after-tax dollars to the fund and when the purchase occurred.

T-Mobile’s Employee Stock Purchase Plan (ESPP) periods are six months:

• 10/1-3/31 and

• 4/1-9/30.

A T-Mobile employee would need to hold shares purchased for at least a year and a half after purchase to receive long-term capital gains treatment on part of the gain.

Let’s say someone purchased with the ESPP on 9/30/2022. The start of their offering period was 4/1/2022. Therefore, they might receive some long-term capital gains treatment if they sell on or after 4/2/2024.

For more, check out: How Does an ESPP Work?

I hope this helps!

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Disclaimer

In addition to the usual disclaimers, neither this post nor these images include any financial, tax, or legal advice.