Musicians, Reduce Your Taxes Without Itemizing

If you used to itemize your tax deductions, chances are you will not be able to do so in 2018 under the new Tax Cuts and Jobs Act (TCJA). While it sounds good that the standard deduction has been increased to $12,000 single and $24,000 married, many musicians are lamenting that they no longer can deduct many expenses from their taxes. (See Tax Bill Passes, Strategies for Musicians.)

As a reminder, these changes impact W-2 employees. Musicians who are self-employed or “1099” can continue to deduct business expenses on Schedule C, as well as take the standard deduction. However, for any taxpayer who used to itemize on Schedule A, we’ve lost the following deductions in 2018:

  • Miscellaneous Itemized Deductions, including all unreimbursed employee expenses, tax preparation fees, moving expenses for work, and investment management fees. W-2 musicians have lost the ability to deduct instruments, equipment and supplies, concert clothes, mileage, home office expenses, union dues, etc.
  • Interest payments on a Home Equity Loan
  • Property Tax and other state and local taxes are now capped at $10,000 towards your itemized deductions.

For a married couple, even if you have the full $10,000 in property tax expenses, you will need another $14,000 in mortgage interest and/or charitable donations before you reach the $24,000 standard deduction amount. If you do have $25,000 in deductible expenses, you would effectively be getting only $1,000 more in deductions than someone who spent zero. And that $24,000 hurdle makes it a lot less attractive to try to maximize your itemized deductions any more.

Under the new law, people are no longer going to be able to say “it’s a great tax deduction” when buying an expensive home. When you take the standard deduction, you’re not getting any tax benefit from being a homeowner or having a mortgage.

So if you’ve lost your itemized tax deductions for 2018, can you you do anything to reduce your taxes? Thankfully, the answer is yes. I’m going to share with you 9 “above the line deductions” and Tax Credits you can use to lower your tax bill going forward.

Above The Line Deductions reduce your taxable income without having to itemize on Schedule A. All of these savings can be taken in addition to the standard deduction.

1. Increase your contributions to your 401(k)/403(b) or employer retirement plan. For 2018, the contribution limits are increased to $18,500 and for those over age 50, $24,500. What a great way to build your net worth and make automatic investments towards your future.

2. Many people who think they are maximizing their 401(k) contributions don’t realize they or their spouse may be eligible for other retirement contributions. If you have any 1099 or self-employment income, you may be eligible to fund a SEP-IRA in addition to a 401(k) at your W-2 job. Spouses can be eligible for their own IRA contribution, even if they do not work outside of the home.

3. Health Savings Accounts are unique as the only account type where you make a pre-tax contribution and also get a tax-free withdrawal for qualified expenses. You can contribute to an HSA if you are enrolled in an eligible High Deductible Health Plan. There are no income restrictions on an HSA. For 2018, singles can contribute $3,450 to an HSA and those with a family plan can contribute $6,900. If you are 55 and over, you can make an additional $1,000 catch-up contribution.

4. Flexible Spending Accounts (FSAs) or “cafeteria plans” can be used for expenses such as child care or medical expenses. These are often use it or lose it benefits, unlike an HSA, so plan ahead carefully. If your employer offers an FSA, participating will lower your taxable income.

5. The Student Loan Interest deduction remains an above-the-line deduction. This offers up to a $2,500 deduction for qualifying student loan interest payments, for those with an AGI below $65,000 single or $130,000 married filing jointly. This was removed from early versions of the TCJA but made it back into the final version.

Tax deductions reduce your taxable income, but Tax Credits are better because they reduce the amount of tax you owe. For example, if you are in the 24% tax bracket, a $1,000 deduction and a $240 Tax Credit would both reduce your taxes by $240.

Tax Credits should be automatically applied by your CPA or tax software. For example, if you have children, you should get the Child Tax Credit, if eligible. (Since it’s only February, there is still time to make a child for a 2018 tax credit!) If you are low income, still file a return, because you might qualify for the Earned Income Tax Credit. But there are other tax credits where you might be eligible based on your actions during the year. Here are four Tax Credits:

6. The Saver’s Tax Credit helps lower income workers fund a retirement account such as an IRA. For 2018, the Savers Tax Credit is available to singles with income below $31,500 and married couples under $63,000. The credit ranges from 10% to 50% of your retirement contribution of up to $2,000. Note for married couples, if you qualify for the credit, it would be better to put $2,000 in both of your IRAs, and receive two credits, versus putting $4,000 in one IRA and only getting one credit. If you have a child over 18, who is not a dependent and not a full-time student, maybe you can help them fund a Roth IRA and they can get this Tax Credit. Read the details in my article The Saver’s Tax Credit.

7. Originally cut out of the House bill, the $7,500 Tax Credit for the purchase of an electric or plug-in hybrid vehicle was reinstated in the final version of the TCJA signed into law. The credit is phased out after each manufacturer hits 200,000 vehicles sold, so if you were planning to add your name to the 450,000 people on the waitlist for a Tesla Model 3, forget about the Tax Credit. But there are many other cars and SUVs eligible for the credit which you can buy right now. There are no income limits on this credit, but please note that this one is not refundable. That means it can reduce your tax liability to zero, but you will not get a refund beyond zero. For example, if your total taxes owed is $5,200, you could get back $5,200, but not the full $7,500.

8. Child and Dependent Care Tax Credit. To help parents who work pay for daycare for a child under 13, you can claim a credit based on expenses of $3,000 (one child) or $6,000 (two or more children). Depending on your income, this is either a 20% or 35% credit, but there is no income cap.

9. New for 2018: The $500 Non-Child Dependent Tax Credit. If you have a dependent who does not qualify for the Child Tax Credit, such as an elderly parent or disabled adult child, you are now eligible for a $500 credit from 2018 through 2025.

Even with the loss of many itemized deductions, you may still be able to reduce your tax bill with these nine above the line deductions and Tax Credits. We want to help professional musicians find Financial Security, whether that is through long-term, diversified investment strategies, by teaching you how to save on taxes, or making sure you can afford to maintain your lifestyle in retirement. If you want an advisor who is knowledgeable about your unique financial needs as a musician, let’s talk about what our program can do for you.

What is Critical and Declining Status?

If you are a participant in the Musicians’ Union Pension, the AFM-EPF, you may have received an email this week that said that thanks to good investment performance, the plan would remain in Critical status but not move into “Critical and Declining” status. The message notes that it is still possible that the plan will become “Critical and Declining” next year or in the future. What does this mean to the future of the plan if you are an active participant or a retiree? Here’s what you need to know.

The US Department of Labor’s Employee Benefit Security Administration (EBSA) is charged with enforcing ERISA regulations regarding retirement plans, including multi-employer pension plans, such as the AFM-EPF. Under ERISA Code Section 305, multi-employer plans which are underfunded fall into three categories. Here is a simplified summary:

  1. Endangered Plans have a funded percentage under 80%. They are required to adopt a Funding Improvement Plan to increase the plan’s funded percentage.
  2. Critical Plans have a funded percentage under 65%. Plans in Critical Status (“red zone”) must implement a Rehabilitation Plan which will enable the plan to emerge from Critical Status.
  3. Critical And Declining is reserved for plans which are projected to become insolvent within 15 years (or in some situations, 20 years).

The current 2016 Rehabilitation Plan from the AFM-EPF indicates that Milliman (the plan actuaries) now projects that the plan will not emerge from Critical Status. The steps taken in 2010 will not be sufficient for the plan to remain solvent.

Once a plan is in the Critical And Declining category, the plan administrators are allowed (but not required) to reduce current and future benefits in order to try to save the plan or increase the amount of time that assets will last. They can reduce benefits to no lower than 110% of the Federally guaranteed minimum under the Pension Benefits Guarantee Corporation (PBGC) rules. Please read my previous article on how to calculate the PBGC guarantees.

As independent fiduciaries, I believe the pension administrators would legally need to consider reducing payouts, even to current retirees, if the plan was labeled as Critical and Declining. Their duty would be to try to save the plan. Needless to say, no one wants to see the pension cut payouts which were promised to participants and retirees. However, the actuaries have already said that the Rehabilitation Plan is not going to work and we should now take “reasonable measures to forestall possible insolvency.”

If you are 80 years old, you might not live to see the plan terminate. But if you are 50 years old, the plan might be taken over by the PBGC before you retire and then you may face a big cut in benefits. For active participants, you would want cuts now to try to save the plan or delay for as long as possible its insolvency. Current participants are already receiving less than 1/4 the payout, $1 versus $4.65, for every $100 contributed compared to contributions made before 2004.

For a retiree, however, having the pension renege on the payment they were promised could be financially devastating. At least the current participant has the option of working longer or getting another job. But in the end, if the plan becomes insolvent, all participants will be reduced to the PBGC payout regardless of what we had been promised or had “earned”.

Unfortunately, there is no easy solution to this mess. We are seeing the same situation in pensions around the country, not just multi-employer plans, but also municipal plans like the Dallas Fire and Police Pension, and even Social Security faces insolvency in less than 20 years. The Pension Industry made fatal mistakes in what they thought they could provide and now participants are going to be left holding the bag. There are only two choices, reduce payouts or increase contributions. But the amount of increases that would be needed to make pensions whole is unfeasible, so I believe we will be forced to accept cuts at some point in the future. The question is whether we will make these changes in a deliberate, well-planned manner, or if we are going to continue to deny the problem until the ship has sunk.

What Would Happen If The AFM-EPF Fails?

Pensions offer what may be the ideal source of retirement income. I have written a number of times about the critical status of the American Federation of Musicians Employer Pension Fund (AFM-EPF), a multiemployer pension plan which covers 50,000 professional musicians in America. Given that the Actuaries do not believe that their rehabilitation plan will enable the plan to emerge from critical status, you may wonder: What would happen to your pension if the plan were to terminate or fail?

The AFM-EPF is covered by the Pension Benefit Guaranty Corporation, a federal agency that was chartered to protect pension plan participants. The PBGC is funded through required employer contributions and receives no tax dollars.

Even though the pension plan is insured, there are limits on the amount of coverage available to individuals through the PBGC. If a plan terminates and you are vested, but not yet retired and receiving benefits, you would be covered only for your currently vested benefits and would not receive any further credit for future work. This is important: The PBGC will only cover vested benefits and a plan termination will halt the accrual of future benefits.

If you are retired and already receiving benefits, the PBGC has limits on the monthly benefit they would cover. If a plan terminates and is taken over by the PBGC, you could see your monthly benefit drop by a significant amount. The PBGC provides different levels of coverage for single-employer plans and multiemployer plans. All the information below relates to multiemployer plans, such as the AFM-EPF.

(If you are also a participant in a single-employer plan, you can find information on PBGC coverage here: PBGC Monthly Maximum Tables.)

For participants the AFP-EPF, your maximum coverage under the PBGC is based on your years of service. If your pension benefit is above the monthly guaranty amount, and the plan were to fail, your benefit would be reduced to the PBGC maximum. Here’s how the PBGC calculates their coverage:

PBGC formula for Multiemployer Plans
100% of the first $11 of monthly benefits,
Plus 75% of the next $33 of monthly benefits,
Times the number of years of service.

The maximum monthly benefit under the PBGC then is $35.75 times the number of credited years of service. For example, if you were a participant for 30 years, your maximum benefit would be $1072.50 a month, or $12,870 a year. And in order to get $35.75 from the PBGC, you’d have to be receiving at least $44 from the pension. In other words, to get the PBGC benefit of $12,870 a year, your pension benefit amount would need to be at least $15,840.

Please note that this example is based on 30 years of service; if you had more or less than 30 years of service, your benefits under the PBGC could be higher or lower. The amounts for Multiemployer plans are not indexed for inflation and do not receive Cost of Living Adjustments. There is no plan to increase these amounts. Link: Multiemployer Benefit Guarantees.

Musicians need to have multiple legs on their retirement plan: pension, Social Security, investment accounts including IRAs, and other sources of income. If you try to have a plan that rests entirely on one leg, you are potentially asking for trouble. The trustees of the AFM-EPF are looking to forestall possible insolvency, but the plan actuaries do not calculate that the plan will ever recover to a fully funded status. In your planning, please consider not only the benefit offered by the EPF, but also make sure you understand and calculate what your benefit would be if the plan were to terminate and be taken over by the PBGC.

AFM Pension Plan Slide Continues

Participants in the AFM Employers’ Pension Fund (AFM-EPF) received the annual funding notice and notice of critical status this week. Unfortunately, this year’s report is not good, and this notice does little to explain why.

Each year, pension administrators are required to evaluate their plan’s “funded percentage” as a measure of the plan’s financial capacity. The funded percentage is the actuarial value of the plan’s assets divided by the actuarial value of its liabilities. A funded percentage of 100% or higher would indicate a fully funded plan. Our plan has been in critical status since 2010, as have many plans, following the crash of 2008-2009 which greatly impacted asset values.

Two years ago, the AFM-EPF, reported a funded percentage of 85.7%. This declined to 81.6% last year, and then to 76% this year, which means that the plan presently has only 76 cents for every dollar of future benefits promised. The funded percentage is based on “actuarial” values, which means that these numbers are actually adjusted to smooth out stock market fluctuations and to discount future benefits back to today’s dollars. Also alarming is a large decline is the actual, “fair market value” of assets.

The fair market value of plan assets sat at $1,823,000,326 as of 3/31/2014, and stayed fairly level over the following year, to $1,818,080,945 as of 3/31/2015. Over the past year, however, assets declined by $114 million to $1,703,971,000, a drop of over 6%. During the most recent plan year (April 1, 2015 to March 31, 2016), the S&P 500 Index delivered a total return of 1.78%, so this wasn’t due to a terrible stock market environment.

It is also worth noting that the fair market value of assets is substantially lower than the actuarial values. As of April 1, 2015 (the most recent value made public), the actuarial value of assets was listed as $2,066,699,976, or $248 million more than the fair market value. That is a quarter billion dollars in smoothing! Over time, as we get further away from 2009, this gap should narrow. The actuarial values should eventually decline towards the fair market values – meaning that the funded percentage is unlikely to improve significantly even if the market performs strongly next year.

Over this same time period, the actuarial value of liabilities has been steadily increasing, from $2.39 billion in 2013 to $2.46 billion in 2014 and $2.53 billion in 2015. Increasing liabilities and decreasing assets are why the funded percentage has worsened.

One of the most significant changes to the plan has been dramatic reduction in the Benefit Multiplier. Put bluntly: the current participants are going to receive less than one-quarter of the benefits promised to previous beneficiaries and are going to bear the pain of the rehabilitation plan, while older participants will still receive their full benefits. Over time, the lower Benefit Multiplier should help improve the funded percentage.

The Benefit Multiplier is used to calculate a monthly payment for each $100 that has been contributed to the plan in your name. The multipliers below are all for retirement at age 65, and contributions earned in the following dates:

  • Before 1/01/2004: $4.65
  • Between 1/01/2004 and 4/01/2007: $3.50
  • Between 4/01/2007 and 4/01/2009: $3.25
  • Between 4/01/2009 and 1/01/2010: $2.00
  • After 1/01/2010: $1.00

Over this time period, the monthly benefit fell from $4.65 per $100 contribution to $1.00. I have to admit, I am baffled how the old payout was ever going to work. Someone who had $100 in contributions in 2003 and retired in 2004 at age 65 would get $4.65 a month, or $55.80 a year for the rest of their life? From $100?

I studied Pension Accounting in the CFA Program, and I understand how these decisions were made. The assumptions are crucial decisions. They assume a rate of return, a number of new and retiring participants, wage and contribution growth, and even the life expectancy of the average beneficiary. Unfortunately, many of these assumptions have proved overly optimistic, not just for the AFM-EPF, but for many pension plans. The rate of return has been lower in stocks since 2000, and is going to be much lower in bonds, going forward. Participants are living longer than the mortality tables (created decades ago) predicted. Growth in contributions and inflation make what seems like high pension payments possible in the future. Unfortunately, employers in music – specifically orchestras and the recording industry – are not areas of high contribution growth either in the number of musicians employed or in covered wages.

The EPF created the Rehabilitation Plan in 2010, which the Actuaries originally thought would enable the plan to emerge from critical status by 2047. Today, they no longer believe that the rehabilitation plan will work, only that it should forestall insolvency for at least 20 years. Past 20 years, they say that it is difficult to predict. This is a troubling development, and it’s not information which was shared in the plan mailing. If you want to find this information, you have to go online and download the June 27, 2016 update to the Rehabilitation Plan. On page 9:

“Currently, Milliman does not project that the Plan will emerge from critical status. Accordingly, the objective of the Rehabilitation Plan is to take reasonable measures to forestall possible insolvency.”

What does all this mean to you?

  1. The plan remains in critical status, and may worsen. The plan actuaries now believe that the rehabilitation plan will not enable to the plan to emerge from critical status. The funded status would be even worse if they used the fair market value of assets rather than the actuarial value.
  2. The plan has already slashed benefits going forward, but may need to lower payouts further if they want to guarantee solvency.
  3. Each year that the funded ratio declines, we are closer to the eventual possibility that the plan will be taken over by the Federal Government, via the Pension Benefit Guarantee Corporation, or PBGC. Note that the PBGC provides a reduced benefit and has a maximum guarantee of $35.75 times the number of years of service. (For example, if you participated for 30 years, your maximum monthly benefit would be $1072.50, even if the AFM-EPF had planned to pay you $2,000 a month.)
  4. Even in the best case scenario, musicians who joined the plan since 2010 will receive a small fraction of the benefits paid to those who had earnings before 2004. Newer participants had better have other sources of retirement income.
  5. The conversation we are having now on the AFM-EPF, all Americans should be having about Social Security. It is also in jeopardy and will not work as originally designed. Benefits promised cannot be delivered. We must make changes, including lowering benefits, lifting the retirement age, and increasing personal savings.

I trust our AFM Leadership to take the steps to fix the EPF. As a multi-employer plan with contribution rates determined by hundreds of CBAs and union agreements throughout the country, increasing contributions further is not a feasible option. Getting the plan to be fully funded may require tough decisions about cutting benefits. If you are concerned about your retirement, whether it is next year or 35 years away, give me a call and we will create a plan for your needs and goals.

Self Employed? Discover the SEP-IRA.

The SEP-IRA is a terrific accumulation tool for workers who are self-employed, have a family business, or who have earnings as a 1099 Independent Contractor. SEP stands for Simplified Employee Pension, but the account functions similar to a Traditional IRA. Money is contributed on a pre-tax basis, and then withdrawals in retirement are taxable. Distributions taken before age 59 1/2 may be subject to a 10% penalty.

How Some Investors Saved 50% More

While some people view risk as synonymous with opportunity, the majority of us don’t enjoy the roller coaster ride of investing.  Our natural proclivity for risk-avoidance can, unfortunately, become a deterrent in deciding how much we save. Without having specific goals, investors often default to a relatively low contribution rate to retirement accounts and other investment vehicles.  They commit only how much they feel comfortable investing, rather than looking at how much they actually need to be saving in order to fund their retirement or other financial goals.