I have to admit – as well as apologize – that with the holidays and the start of the new year, along with diligently focusing on getting the word out there about my new book, “From Millennial to Millionaire: DIY 401(k),” I’ve just been busier than ever. And consequently, I haven’t been able to write and publish as many posts as I would like. And yet there’s so much to talk about given the sheer amount of changes within the finance world that have been noteworthy, sweeping, and, perhaps even at times, overwhelming. To name but a few of these changes, we have seen the most consequential tax change enacted into law since the 1980s; cryptocurrencies are gracing headlines every day; and the stock market seems invincibly optimistic and bullish, with the Dow Jones hovering around 26,000, having just unprecedentedly surpassed 25,000 last week.
In this post, I would like to comment on two of these topics, mostly from a 401(k) retirement investing perspective: Trump’s tax legislation and the current bull market. Attention must be paid, and these two items are set to impact your personal finances as the year begins and moves forward. (I’ll defer cryptocurrencies – i.e. Bitcoin – to a later date. Let’s see if it continues to nosedive or if it turns around.) And so it’s important that you understand these changes and the implications of such on your financial welfare, as it impacts everyone, from low-earners to high-earners, to misers and to savers, to young millennials and to blue-haired retirees. Let’s take a look at these two phenomena and what it means for your wallet – and investing.
1) Let’s talk tax legislation and your 401(k). On Friday, December 22, President Trump signed into law the most sweeping tax legislation to impact the American people since the 1980s. First off, despite all the back and forth on proposals to lower 401(k) contribution rates and to ‘rothify’ the 401(k) system, none of these were approved, and essentially the 401(k) has remained unchanged, with some slight minor adjustments to hardship withdrawals. But even better, on the positive side, contribution rates have risen to $18,500 in 2018, up from $18,000 in 2017.
More broadly and in brief, the tax law maintains a seven-tiered progressive federal tax structure, but rates across the board have been cut. Here is the side-by-side view of 2017 versus 2018 marginal taxes for single filers (OK, I don’t include married (joint) or head of household, but this is an illustration). And remember that this impacts your marginal rate, meaning the highest rate impacts only the next dollar of income that you earn.
|2017 taxable income||2017 tax bracket||2018 taxable income||2018 tax bracket|
|$0 – $9,075||10%||$0-$9,525||10%|
|$9,075 – $36,900||15%||$9,526-$38,700||12%|
|$36,900 – $89,350||25%||$38,701-$82,500||22%|
|$89,350 – $186,350||28%||$82,501-$157,500||24%|
|$186,350 – $405,100||33%||$157,501-$200,000||32%|
|$405,100 – 406,750||35%||$200,001-$500,000||35%|
Immediately, two things stand out to me from these changes to individual marginal tax rates:
- 3-4% (-ish) tax break for the middle class and millennials, for that matter. First, when you eyeball 2017 vs. 2018 taxable income and tax brackets, the adjustments seem almost subtle. The first four taxable income tiers are roughly unchanged, and their corresponding tax rates have been reduced by around 3-4%. Objectively, this is beneficial to the earners in these tax brackets – you get a 3-4% pay increase. For example, the average millennial earner makes $47,000 each year. In 2017, she would pay a marginal tax rate of 25%, and owe $11,750 in taxes. In 2018, she would be liable to a 22% tax rate and owe $10,340. (Please note that these numbers are a simplified illustration.) So she each gets to keep an extra $1,410 starting in 2018.
- The upper-middle class will pay more in marginal tax rates. Second, and this may seem counterintuitive, but what’s noticeable is that once you get to the three highest brackets, there’s a drastic change in the tax income bracket for the 33% and 32% rate, and in fact, earners making between roughly $200k-$400k will be paying more in taxes. It’s an unusual occurrence in my opinion, but beyond that, the tax rate lowers for the wealthiest earners (>$500k).
With this extra money, particularly for millennials, there are at least two things to seriously consider with your 401(k):
- You’ll have more disposable income to allocate towards 401(k) savings. You could use this to add more to your 401(k), IRA, or to an emergency savings account in 2018. The US government has just given you a raise – so take advantage of this opportunity. Certainly, fewer taxes means more money in your wallet with each paycheck, but with more money in your pocket comes more responsibility. Don’t just increase your spending in 2018, but deploy that extra money in the most beneficial way to you. Let’s say you’re 30 right now and plan to retire at 67, if you were to save that extra $1,410 over the next 37 years until age 67, your 401(k) accounts would raise an extra $320,000! If you are 22 today and save an extra $1,410 over the next 45 years, you’d have an extra $620,000!
- A Roth becomes even more compelling for millennials, given the lowered tax rates. Another impact to be mindful of is if you contribute to a traditional 401(k), in which you get a tax break up-front, with the lower tax brackets your tax savings will be less because taxes are lower. So with taxes lowering, it may be good to assess if you are in the right 401(k) account – traditional vs. Roth – now that taxes are lower starting in 2018. When you are young and investing, you may end up with more income in retirement, which would be taxed higher. A Roth would be advantageous here because you’d benefit paying even fewer taxes today on your contributions, and paying no taxes in retirement! With this decision, it will be important to consult a qualified tax advisor.
There’s also a lot of discussions centered not just on the adjustments to the individual tax rates but also on a buffet of additional changes that the tax law implements. These additional changes impact those who itemize their tax return versus take the standard deduct, impact entrepreneurs and investors, and impact various other stakeholders. These additional changes include, but are not limited to:
- The standard deduction is raised $12,000 for single or married filing jointly
- Various changes to itemized deductions: you can still deduct state/local/property taxes, but it’s limited to $10,000
- Personal exemptions/deductions are gone
- The individual mandate for ObamaCare is abolished starting in 2019
- Capital gains taxes are unchanged
The tax legislation will impact each person differently. It will be important that you work with a professional tax advisor to better understand your individual changes. And finally, the tax legislation lowered the corporate tax rate from 35% to 21%….which brings me to my next point.
2) Properly take advantage of the stock market’s euphoria. Since the start of this year, the stock market has already returned an impressive return, with the S&P 500 up 5% so far already beating year-end expectations. And much of this rising tide has can be attributed to the changes in the corporate tax provisions, provided in the new tax legislation. Why is this so?
As we know, the stock market is the exchange where buyers and sellers go to in order to buy and sell stocks, which are shares of ownership in a company that a publicly traded company issues in order to raise money (or in finance parlance, “capital”). And the price of these stocks is determined – in theory – by the discounted cash flow of the issuing company’s earnings.
So, with fewer taxes that companies will have to pay, they will earn more, and therefore stock prices are increasing with the now-certain projection that earnings will rise. Case in point, the Dow Jones surpasses 26,000 this week, having just passed 25,00 last week. That’s a 1,000 change in one week – it’s euphoric. It took the stock market since November to rise from 24,000 – and even that was impressive, at the time.
A couple of comments are in order here:
- Don’t buy into the doomsday predictions. First, it’s excellent that the stock market rose almost 25% in 2017, if you’re invested properly in equity, you’re 401(k) but be brimming right now. But let’s remember that the average investment return is 8%. So, while we can expect the stock market to rise, at some point it’s bound to go down – and that is normal! But despite what I hear from many, many naysayers, it’s not going to crash. I don’t envision a 2009 crash on the horizon. And, honestly, if it were, remember that investing is for the long-term, so the best advice would be to just stay calm. Let’s recall that even with the seemingly monolithic “crash” of 2009, the stock market returned to pre-crash levels within 3 years – that’s a drop in the bucket if you’re investing for 30-40 years.
- Stay invested in low-cost index equity. Second, make sure that you are taking full advantage of this bull market by being invested in equity. There’s talk that the market is priced too high, but we know that the key to investing success is asset allocation. With consumer confidence high, corporate earnings expected to go up, and the domestic and international economies being quite healthy, there’s reason to continue to expect the market to rise. So don’t wait and try to time the market when you think you’ll get a better deal. A great place to stash your cash would be in a very simple S&P 500 index fund to get as broad of an exposure to equity as you possibly can. Keep it boring and you will reap the most benefits!
What does this mean for you as a DIY investor going from a Millennial to a Millionaire? There are two practical implications I can think of here for you, and they’re fairly self-evident…
- With the tax decrease, increase your retirements savings in your 401(k)/IRA, and
- With the bull market, ensure you’re properly invested in a low-cost index fund.
That’s really it. Keep it simple, folks!
Follow me on Twitter @MatthewKMiller.
Want to learn more? Pick up a copy of my book …
From Millennial to Millionaire: DIY 401(k) – 5 Do-It-Yourself Steps for the Digital Generation to Design and Manage their 401(k) on Amazon.