Market Musings Blog

Oregon vs Washington: Should I Move Across the River to Save Taxes?

Residents of Portland, Oregon are only a matter of a handful of miles across the Columbia River from a completely different tax regime, in Washington. Does it make any sense to move to Washington for retirement or when selling a business, to save on taxes? We have spent some time on this notion and here are some differences that could compel a decision one way or another:

Washington:

No income tax

Property tax rates range from about 1.10% of RMV in Clark Co to 1% if you move into King Co where Seattle is

Sales taxes in Clark Co are roughly 7.4% to 8.4% depending on where in the Co you live, with some exclusions for food, drugs, and so forth

Car registration fees are substantial, and based on value of vehicle; a $25,000 car registered in 2016 cost about $550 in addition to the regular registration fee of around $30.

Health care costs can be substantial if you must use the Obamacare exchanges as Washington has had a difficult time generating participation by insurance companies. We don’t have exact numbers here, but be certain to check these costs before you move across the River.

Inheritance taxes start at $2,193,000.

If you are moving a business to Washington, be sure to check licensing fees and the business and occupation tax, which is based on gross receipts.

Oregon:

Hefty income tax, with a top rate of 9.9%. Social Security is exempt, and there is a small credit for taxes on pension income.

Property tax rates are similar to Washington, slightly higher in Multnomah County at 1.13%.

No sales tax.

Car registration is a flat fee for licensing, in the $100-$200 range depending on the plates you want.

Inheritance taxes start at only $1 million.

If your business in Oregon is a C-corp or an LLC treated as a corporation, you will pay an excise tax of 6.6% to 7.6% in Oregon on income.

Given these differences, it appears that owners of large estates or those who may be subject to substantial required minimum distributions from pension or IRA accounts could profit from a move to Washington state, thereby sheltering income and assets from these taxes. There may be other situations when a move could make sense; but consult with your tax advisor!

 

Stocks Behaving Badly vs Your Plans

We often advise clients about short term investments, such as how to save for the imminent purchase of a home or for a child soon to enter college. In the midst of a bull market, it seems tempting to buy a stock fund to sock away that cash. However, that’s a bit of a roll of the dice. Stock market history since 1926 contains 9 decades in which returns were 3% or less per year, slightly more than 11% of the decades we measured. Four of those periods showed negative returns – that is, an investor in stocks lost money for ten years. These examples were clustered around some of the most notable bear markets in US history – the Great Depression, the crash of ’73-’74, and the Great Recession.

Saving for a short term objective by utilizing an investment where good results tend to require a long term commitment is a risky strategy, particularly from a viewpoint near the top of the multi-year bull market that we are experiencing. We call this ‘liability mismatch’: the moment you must write tuition checks comes before the best years of your investment returns.

Even if you have an investment program in place for your retirement – which would likely be a long horizon plan – recognize that when you need to fund a short term objective, your time horizon on that portion of your portfolio has shortened, and it might pay to raise cash or use short term bonds to fund it, rather than staying put. Otherwise, that tuition check could coincide with a nasty market decline, forcing sales at low prices.

Puerto Rico Causes Municipal Debt Tremors

Even since the Great Recession, municipal bonds have seen more trouble than is normal for this usually super-safe segment of the bond market. Several municipalities in California filed for bankruptcy (Stockton, Vallejo, San Bernardino), then there was Detroit, and now we have the Mother of them all, Puerto Rico.

I won’t bore you with the myriad interesting things about Puerto Rico’s bankruptcy, which is truly special in so many ways – except for this one ominous item. Judge Laura Taylor Swain, who is overseeing the bankruptcy of PR, ruled in mid May that revenue bonds backed by revenues could not, in fact, be paid by those revenues in bankruptcy situations until relief is granted from the automatic stay triggered by the filing itself. This was quite a surprise to participants.

Revenue bonds were heretofore assumed to have a direct lien on revenues that are generated by projects financed by the bonds, such that they stood above the fray in a bankruptcy filing. That meant that so long as the revenues were still being generated, the bonds would be paid. This is how Vallejo worked, for instance; Vallejo taught us that in fact GO bonds were vulnerable. GO bonds had always been thought to be of the highest quality, since their repayment could simply be secured by raising taxes. Instead, Vallejo’s revenue bonds turned into the champs, as revenues kept coming in, for electricity payments, sewer and water payments, and so forth. Meanwhile, everyone has found out that a bankrupt municipality can rarely raise taxes.

So now, derived from the PR proceedings, we have now been told in no uncertain terms that the court will decide the disposition of every iota of cash, not relevant bankruptcy code.

Of course this will go to appeal. However, it’s a very interesting development for municipal bond holders, who have just been reminded that if your bond issuer ends up in court, you might as well throw out the debenture. You’ll just have to wait for the courts to give you what crumbs can be spared.

Buckle Up

By now everyone has noticed that 2018’s stock market is far different from 2017’s stock market. The first round of volatility was blamed on higher interest rates. But in fact by then the tax cut had passed and it’s pretty common for stocks to sink after the realization of an expected event. Investors have a phrase for this: ‘buy the rumor, sell the news’. Stocks discount future news, so good news is already anticipated in stock prices. Since reality is often disappointing versus anticipation, such selloffs are normal.

Then, folks started to fret about deficits after the budget deal was signed. Most recently, volatility is blamed on political uncertainty around trade tariffs.

But it could be anything. After enormous returns in the last few years, the market is ready to view the future with skepticism. Under another president, with a different cabinet, provoking completely different events, the market would still be more volatile than in the last year, when volatility was near an all time low for the longest period ever.

Meanwhile, world growth is slogging along, not at a great rate but definitely in the upward direction. Oil prices are higher, housing prices are rising and sales are solid; construction is robust as states finally improve infrastructure. A generation of citizens is finally healing from the Great Recession, with employment prospects excellent and wages rising. The tax law in the US has inspired other countries to think about reducing tax burdens, and foreign companies are considering locating in the US. It is true that debt has been increasing worldwide, which could turn into a major problem down the road. But the weight of the evidence so far is on the positive side.

So we would counsel looking past the volatility and keeping an eye out for buying opportunities. Identify a few stocks you’d like to own, set a price you’d like to buy at, and then wait for it.

The Mystery of Traditional IRA Withdrawals

We are asked more often these days about required minimum withdrawals – how they work, why they must happen, and particularly, can taxes on RMDs be avoided.

The concept of the IRA contains an implicit agreement between you, as the IRA owner, and the federal government. The deal is this: you get to put away money (and often deduct those contributions), and you get to accumulate your earnings tax free, but only until you turn 70 ½. (No, we don’t know why the age 70 ½ was chosen, except it seems to be a compromise between retirement age and ‘really old’.) Once you turn 70 ½, the IRS wants its pound of flesh, and it insists that you draw the money out on a schedule that’s designed to exhaust the IRA, or nearly so, during your lifetime, so that money can finally be taxed. Overall, it’s a good deal, since it is better to pay taxes in the future versus today. (The ROTH flips this relationship on its head, agreeing that if you pay tax now, you get to get out of paying tax during accumulation and later.)

The tax on RMDs really can’t be avoided. The closest to avoidance is the Qualified Charitable Distribution, which allows you to donate your RMD or part of it directly to a charity (not your own foundation by the way). In that case, the tax on the withdrawal is nearly or completely cancelled by the deduction for the donation.

One hallmark of IRA RMDs is that they generally grow larger the longer you live. The RMD calculation uses the 12/31 prior year market value and your age and life expectancy to come to an amount that must be drawn (inherited IRAs and IRAs with young beneficiaries use other factors in the calculation as well). Each year, your RMD can rise due to a higher market value and/or a shorter life expectancy. The table below shows how life expectancy can affect draws:

As you can see, living into your 90s kicks off a 10% withdrawal rate.

The gradual acceleration of withdrawals makes management of this process critical. High cash flow – ie, choosing stocks with higher than average dividend yields and gearing the bond portion of the portfolio towards higher yields – is one way to deal with the depletion of the IRA asset base. More risk tolerant investors might want to trust capital appreciation in stocks to ‘pay for’ their distributions, but in a bear market, that can produce a disaster.

However one chooses to manage the distribution phase of traditional IRAs, it’s wise to remember that when staring at a $1 million IRA, you don’t really have $1 million; you have $1 million minus the tax that will be paid as that asset base pays your RMDs. This is a critical fact for retirement planning.