Wealth Management

Homestead Exemption – Protect Yourself from Creditors & Reduce Property Taxes

By:  Henry VanBuskirk, CFP®, Wealth Manager

One of the most heavily quoted statements that I’m sure that you have heard at some point in your life is, “Nothing in life is guaranteed, except for death and taxes”. I’m not here to tell you about a magical snake oil that makes you live forever (since that of course doesn’t exist). We live in the real world where death and taxes are unavoidable. I am here to talk to you about how you can help protect yourself and your family from the effects of a loved one’s passing away, how you can legally reduce your property tax bill depending on which state you live in, and how you can help shield yourself from creditors. What I am talking about is electing a homestead exemption.

Each state has its own homestead rules and for purposes of making a succinct article, I am only going to focus on California, Arizona, Florida, and Texas. If your primary residence is in one of the other 46 states, please check with your local county assessor’s office to check what the rules are and what options are available to you in your state.

First off, what is the homestead exemption? The homestead exemption is a way to minimize property taxes for a homeowner’s primary residence. It is also a legal provision that also can help shield a home from unsecured creditors following the death of a homeowner’s spouse or the declaration of bankruptcy.

 Here is an example of how the homestead exemption can help lower your property tax bill.

Example:  Assume that the value of your home is $500,000 and your property tax rate is 1%.  Your property tax bill would then be $5,000.  Assume that you are eligible for a homestead exemption of $50,000.  This would then reduce the taxable value of your home to $450,000.  Your property tax rate would still be 1% and your property tax bill would be reduced to $4,500.

There is also a legal provision that allows unsecured creditor protection against the forced sale of your home when you elect the homestead exemption. Notice how it states ‘Unsecured’ instead of ‘Secured’ creditor protection. An unsecured creditor is any creditor that is loaning money to you without obtaining specified assets or collateral. Some examples of unsecured debt include credit cards, student loans, and unpaid medical bills. A secured creditor is any creditor that is loaning money to you with obtaining specified assets or collateral. Some examples of secured debt include a mortgage, auto loans, and a line of credit against your investment account.

It is important to discuss what the homestead exemption can and can’t do, so that one does not have unrealistic expectations on what asset protection and property tax bill reduction a state will allow. In general, the protection against unsecured creditors is limited and is only applicable to the homeowner’s equity in the home. If the limit is exceeded, unsecured creditors still may force a sale of the home, but the homeowner may be allowed to keep a portion of the proceeds. It will also not stop a bank foreclosure.

Now that we have the basics down, I will now get into more detailed information for California, Arizona, Florida, and Texas.

California

California passed Assembly Bill 1885 back in 2020. This legislation dramatically increased the unsecured creditor protection in California to a minimum of $300,000 or the median price of a home in your county, not to exceed $600,000. For example, the median home price in Orange County (OC) is $1,100,000, so anyone in OC would get an exemption of $600,000. Given the current home valuations in CA, it is hard to think anyone would get $300,000. Most likely, individuals will get whatever the median home value is in their county. The California Constitution provides a $7,000 reduction in the taxable value for a qualifying owner-occupied home. The home must have been the principal place of residence of the owner on the lien date, January 1st.

To apply for a homestead exemption, you would do so by completing the application online with your local county assessor’s office. It is also recommended that you discuss with your local county assessor’s office your unique situation and what options are available to you.    

Arizona

Arizona does have homestead exemption laws, but none of those laws allow you to decrease the taxable value of your home for purposes of potential savings on property taxes.  As of January 1, 2022, Arizona  increased the homestead exemption to $250,000 from the forced sale of your home by unsecured creditors for any person who:

  • Has an interest in real property (owns a single-family residence), or
  • Owns a condo, or
  • Owns a mobile home, or
  • Owns a mobile home plus the land on which that mobile home located.

This legislation though did weaken the protections provided by the homestead provision for individuals as well. This bill provides more ways for creditors to collect on civil judgments.

Florida

Florida is one of the few states that have unsecured creditor protection. Simply put, a creditor cannot force the sale of a homestead to satisfy a judgment. This protection from creditors combined with the fact that Florida does not impose state income taxes, shows why it’s not surprising to see more and more people relocating to the Sunshine State. Florida also allows for the following homestead exemption rules that all must be applied for. Applying for a homestead exemption would grant you the following:

  • A $25,000 exemption that is applied to the first $50,000 of your property’s assessed value if your property is your permanent residence and is owned on Jan 1st of the tax year applied for.  This applies to all taxes, including school district taxes.
  • An additional exemption of up to $25,000 is applied if your property’s assessed value is between at least $50,000 and $75,000. However, this exemption is not applied to school district taxes.
  • You could also qualify for the 3% Cap Save Our Homes assessment limit. This limits the increase to the assessed value of a homestead property for tax purposes to a maximum of 3% per year or the amount of the change in the Consumer Price Index, whichever is lower.

You would apply either by an online application or by going to your local county property appraiser’s office for a paper application. Either way, it is recommended that you discuss your unique situation with your local county property appraiser’s office to check what options are available to you.

Texas

Texas, like Florida, also offers unsecured creditor protection and does not impose a state income tax. This of course does have some limitations. The property tax in Texas is locally assessed and locally administered tax. However, there are some limits based on the acreage and use of the homestead. 

Here are the many types of exemptions available to you if you are applying for a homestead exemption:

  • A $40,000 residence homestead exemption for the home’s value for school taxes.
  • If there is a special tax for farm-to-market roads or flood control, you may receive a $3,000 exemption for this tax. If your county grants an optional exemption for homeowners aged 65 or disabled, that household would only receive the local-option exemption
  • For Disabled persons or persons aged 65 or older:
    • You can qualify for a $10,000 residence homestead exemption for school taxes in addition to the $40,000 exemption for all homeowners. If the owner qualifies for both the $10,000 exemption for over 65 and the $10,000 exemption for disabled homeowners, the owner must choose one or the other for school taxes.
    • Any taxing unit may offer an additional exemption up to $3,000.

To apply for a homestead exemption, you would need to check with your local appraisal district on how to apply and discuss what options are specifically available to you.

Summary:

The goal of this article is to get you thinking about asset protection planning and to offer our services to help you reach your asset protection goals. Our team can work with you and an attorney to make sure those goals are being satisfied.

Sources:

  1. https://www.investopedia.com/terms/h/homestead-exemption.asp
  2. https://www.investopedia.com/terms/u/unsecuredcreditor.asp
  3. https://www.investopedia.com/terms/s/secured-creditor.asp
  4. https://www.boe.ca.gov/proptaxes/homeowners_exemption.htm
  5. https://www.boe.ca.gov/proptaxes/homeexem.htm
  6. https://www.sccassessor.org/tax-savings/transferring-your-assessed-value/senior-citizen-over-age-55-outside-county
  7. https://www.azleg.gov/ars/33/01101.htm
  8. https://www.pbcgov.org/papa/3-percent.htm
  9. https://www.pbcgov.org/papa/homestead-exemption.htm
  10. https://comptroller.texas.gov/taxes/property-tax/exemptions/
  11. https://www.realtor.com/realestateandhomes-search/Orange-County_CA/overview   

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s website or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy (including those undertaken or recommended by Company), will be profitable or equal any historical performance level(s). Please see important disclosure information here.

The Best Strategies for your Required Minimum Distributions

By:  Henry VanBuskirk, CFP®, Wealth Manager

The current rule states that you must take your first Required Minimum Distribution (RMD) by April 1st of the year after you reach 72 and annually thereafter by December 31st of each year. When the SECURE Act became law on December 20, 2019, the RMD age was pushed back from age 70.5 to age 72. 

Plans affected by RMD rules are: 401(k) plans, 403(b) Plans, 457 Plans, Traditional IRAs, SEP IRAs, SIMPLE IRAs, Inherited IRAs and Inherited Roth IRAs. Defined Benefit and Cash Balance plans satisfy their RMDs by starting monthly benefit payments (or a lump sum distribution) at the participant’s required beginning date.

If you’re still employed by the plan sponsor of a 401(k) and are not considered to be a more than 5% owner, your plan may allow you to delay RMDs until you retire. The delay in starting RMDs does not extend to owners of traditional IRAs, Simplified Employee Pensions (SEPs), Savings Incentive Match Plans for Employees (SIMPLEs) and SARSEP IRA plans.

The RMD value is calculated based on the qualified investment account’s value on December 31st of the prior year and is based on standardized IRS guidelines (i.e., the RMD for 2022 is based on the value of the account on 12/31/2021). The prior year’s year-end balance is divided by a life expectancy factor issued by the IRS.

 If you have more than one IRA, you must calculate the RMD for each IRA separately each year. However, you may aggregate your RMD amounts for all your IRAs and withdraw the total from one IRA or a portion from each of your IRAs. You do not have to take a separate RMD from each IRA. If you have more than one defined contribution plan, you must calculate and satisfy your RMDs separately for each plan and withdraw that amount from that plan (Exception: If you have more than one 403(b) tax-sheltered annuity account, you can total the RMDs and then take them from any one (or more) of the tax-sheltered annuities).

For inherited IRAs and inherited Roth IRAs, if the account was inherited before the SECURE Act was passed, you can take RMDs over your life expectancy. If you inherited the account after the SECURE Act was passed, there are no required annual distributions, but the account must be depleted within 10 years of the account owner’s death unless the beneficiary is a spouse, a disabled or chronically ill individual, or a minor child until they reach the age of majority. 

Now let’s take a look at the options available to you for your IRA, 401(k), or another qualified investment account subject to RMD rules.

Option 1 – Take your RMD.

This is the most straightforward option. You can take your RMD (or a greater amount if needed), withhold the appropriate federal and state taxes from the distribution, and use the net distribution as needed. If this is your first year taking your RMD, you can take two RMDs in the first required year. This is because the rules say by April 1st following the year you turn 72. Therefore, you could take your 2022 RMD on February 15, 2023, and your 2023 RMD on June 30, 2023. Doing this would allow you to delay the first year’s RMD for tax purposes for only the first year and means that the 2022 RMD wouldn’t affect your 2022 tax return. However, Uncle Sam will eventually get his recompense and your 2023 tax return would reflect your 2022 RMD and 2023 RMD with this strategy. Note that RMDs are taxed at ordinary income rates.

Option 2 – Don’t take your RMD.

Please don’t go with this option. The IRS has a very steep penalty for those who don’t take their RMD.  The IRS penalty is 50% of the amount not taken on time.  In general, even if you don’t need the money.  You really should take it.  As you will see later, there are many options available to you even if you don’t need the money.

Option 3 – Take your RMD and invest those proceeds into a non-qualified investment account.

With this option, you would take the RMD as normal and withhold federal and state taxes and invest the net distribution into a non-qualified (taxable) investment account. The non-qualified account could be used for general savings to be used during your lifetime, an inheritance to gift to your beneficiaries after your death, or to help save for a future unexpected expense like a long-term care need.

Option 4 – Qualified Longevity Annuity Contract (QLAC).

A QLAC is a strategy where you put in the lesser of 25% of the total value of all your qualified investment accounts or $145,000. A QLAC allows you to fund an annuity contract as early as age 65 and delay income received from the annuity until age 85. The QLAC itself does not count towards the RMD calculation, but the income received from QLAC is treated as ordinary income. This sounds like the slam dunk option, right? Wrong. The answer is it depends on your unique situation (like most answers in financial planning). Yes, a QLAC would help lower the tax bill during the years you defer taking income from the QLAC, at the cost of less net money in your pocket during the early years of your retirement and annuity payments that do not generally have a cost-of-living adjustment tied to them that would increase your tax bill because you still have RMDs on top of the QLAC payments. A QLAC is generally also an irrevocable decision. We would be happy to discuss the pros and cons of purchasing a QLAC if you have further questions.

Option 5 – Qualified Charitable Distribution (QCD).

For the altruist (who also likes not paying taxes), a QCD is an option. If there is a charity (a 501(c)(3) organization) that you feel passionate about, you can donate up to $100,000 per year (as of tax year 2022) directly from your qualified investment account to that charity tax-free. This helps you avoid the distribution being included in your taxable income and is especially valuable for those who don’t typically itemize on their tax returns. The key word is “directly”, as if you physically take the RMD check and then turn around and write a check to that charity, that does not count. For those over age 70.5, QCDs can be used before you are required to take your RMD at age 72. We can work with you to make sure that your QCD is done correctly.

Option 6 – College Planning.

Maybe you have a sizable estate and are concerned about making sure your grandchildren can attend college. With this option, you can put the net RMD funds into a 529 Plan that would grow tax-free and withdrawals can be tax-free if the funds withdrawn from a 529 Plan are used for qualified educational expenses (i.e., tuition, books, room and board, etc.). Contributions to this investment account may even be tax-deductible in your state. Also, since this is considered a gift, you are lowering the size of your taxable estate, which could help your heirs at the time of your passing. Normally you are only allowed to gift $16,000 per year (or $32,000 per year if you elect gift splitting with your spouse) per beneficiary. But with a 529 plan, you can gift 5 years’ worth of gifts in only one year (“superfunding”).  This means that you could potentially gift $80,000 per beneficiary for a single tax filer or $160,000 per beneficiary for a married couple into the 529 plan and lower your taxable estate by that amount. There are a few moving parts in this example, including possibly filing a gift tax return, so we would need to work with you and possibly your accountant and estate planning attorney to make sure this would all go according to plan.

Now that we have an idea of the different options available to you, we would like to illustrate examples of how some of these options can be used in a real-world setting.

*If you have a QLAC, the calculations could differ, but the general idea of the flowchart would still be the same. 

The goal of this article was to illustrate that there are many different options available to you (including ones not illustrated in this article). Also, check out this 2-minute BFSG Short which gives a high-level overview of the most important things to know about RMDs. Our team is available to discuss these concepts with you in further depth if you have any other questions and to evaluate what option would be best for your unique situation.  

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s website or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy (including those undertaken or recommended by Company), will be profitable or equal any historical performance level(s). Please see important disclosure information here.

Monthly Market Update (July): 3 Things You Need to Know

Investors bought the dip in July on hopes the Federal Reserve is about to change course and relax policy before inflation has even peaked.

Here are 3 things you need to know:

  1. July was the best month for the S&P 500 since November 2020, when the first vaccine trial results were reported.
  2. High yield corporate bonds returned +5.9% in July (total return), the strongest monthly performance since 2009.
  3. Gross Domestic Product (GDP) fell at a 0.9% annualized rate in the 2nd quarter, marking the second consecutive quarter of declining economic output.

Sources:

  1. Sources: J.P. Morgan Asset Management – Economic Update; Bureau of Economic Analysis (www.bea.gov); Bureau of Labor Statistics (www.bls.gov); Federal Open Market Committee (www.federalreserve.gov)
  2. Indices:
    • The Barclays Aggregate Bond Index is a broad-based index used as a proxy for the U.S. bond market. Total return quoted.
    • The S&P 500 is designed to be a leading indicator of U.S. equities and is commonly used as a proxy for the U.S. stock market. Price return quoted.
    • The MSCI ACWI ex-US Index captures large and mid-cap representation across 22 of 23 developed market countries (excluding the U.S.) and 27 emerging market countries.  The index covers approximately 85% of the global equity opportunity set outside the U.S. Price return quoted.
    • The MSCI Emerging Markets Index captures large and mid-cap segments in 26 emerging markets. Price return quoted (USD).

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s website or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy (including those undertaken or recommended by Company), will be profitable or equal any historical performance level(s). Please see important disclosure information here.

The Health of Social Security: Some Good News and Some Bad News

With approximately 94% of American workers covered by Social Security and 65 million people currently receiving benefits, keeping Social Security healthy is a major concern.1 Social Security isn’t in danger of going broke — it’s financed primarily through payroll taxes — but its financial health is declining, and benefits may eventually be reduced unless Congress acts.

Each year, the Trustees of the Social Security Trust Funds release a detailed report to Congress that assesses the financial health and outlook of this program. The most recent report, released on June 2, 2022, shows that the effects of the pandemic were not as significant as projected in last year’s report — a bit of good news this year.

Overall, the news is mixed for Social Security

The Social Security program consists of two programs, each with its own financial account (trust fund) that holds the payroll taxes that are collected to pay Social Security benefits. Retired workers, their families, and survivors of workers receive monthly benefits under the Old-Age and Survivors Insurance (OASI) program; disabled workers and their families receive monthly benefits under the Disability Insurance (DI) program. Other income (reimbursements from the General Fund of the U.S. Treasury and income tax revenue from benefit taxation) is also deposited in these accounts.

Money that’s not needed in the current year to pay benefits and administrative costs is invested (by law) in special government-guaranteed Treasury bonds that earn interest. Over time, the Social Security Trust Funds have built up reserves that can be used to cover benefit obligations if payroll tax income is insufficient to pay full benefits, and these reserves are now being drawn down. Due to the aging population and other demographic factors, contributions from workers are no longer enough to fund current benefits.

In the latest report, the Trustees estimate that Social Security will have funds to pay full retirement and survivor benefits until 2034, one year later than in last year’s report. At that point, reserves will be used up, and payroll tax revenue alone would be enough to pay only 77% of scheduled OASI benefits, declining to 72% through 2096, the end of the 75-year, long-range projection period.

The Disability Insurance Trust Fund is projected to be much healthier over the long term than last year’s report predicted. The Trustees now estimate that it will be able to pay full benefits through the end of 2096.  Last year’s report projected that it would be able to pay scheduled benefits only until 2057. Applications for disability benefits have been declining substantially since 2010, and the number of workers receiving disability benefits has been falling since 2014, a trend that continues to affect the long-term outlook.

According to the Trustees report, the combined reserves (OASDI) will be able to pay scheduled benefits until 2035, one year later than in last year’s report. After that, payroll tax revenue alone should be sufficient to pay 80% of scheduled benefits, declining to 74% by 2096. OASDI projections are hypothetical, because the OASI and DI Trust Funds are separate, and generally one program’s taxes and reserves cannot be used to fund the other program. However, this could be changed by Congress, and combining these trust funds in the report is a way to illustrate the financial outlook for Social Security as a whole.

All projections are based on current conditions and best estimates of likely future demographic, economic, and program-specific conditions, and the Trustees acknowledge that the course of the pandemic and future events may affect Social Security’s financial status.

Many options for improving the health of Social Security

The last 10 Trustees Reports have projected that the combined OASDI reserves will become depleted between 2033 and 2035. The Trustees continue to urge Congress to address the financial challenges facing these programs so that solutions will be less drastic and may be implemented gradually, lessening the impact on the public.  Many options have been proposed, including the ones below. Combining some of these may help soften the impact of any one solution.

  • Raising the current Social Security payroll tax rate (currently 12.4%). Half is paid by the employee and half by the employer (self-employed individuals pay the full 12.4%). An immediate and permanent payroll tax increase of 3.24% to 15.64% would be needed to cover the long-range revenue shortfall.
  • Raising or eliminating the ceiling on wages subject to Social Security payroll taxes ($147,000 in 2022).
  • Raising the full retirement age beyond the currently scheduled age of 67 (for anyone born in 1960 or later).
  • Raising the early retirement age beyond the current age of 62.
  • Reducing future benefits. To address the long-term revenue shortfall, scheduled benefits would have to be immediately and permanently reduced by about 20.3% for all current and future beneficiaries, or by about 24.1% if reductions were applied only to those who initially become eligible for benefits in 2022 or later.
  • Changing the benefit formula that is used to calculate benefits.
  • Calculating the annual cost-of-living adjustment (COLA) for benefits differently.

A comprehensive list of potential solutions can be found at here.

Sources:

1) Social Security Administration, 2022

Prepared by Broadridge Advisor Solutions. Edited by BFSG. Copyright 2022.

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s website or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy (including those undertaken or recommended by Company), will be profitable or equal any historical performance level(s). Please see important disclosure information here.

BFSG Investor’s Forum & Luncheon

We are grateful to our clients who joined us at BFSG Investors’ Forum & Luncheon in Newport Beach at Balboa Bay Resort for in-depth discussions on geopolitics & globalization with Matt Gertken of BCA Research, innovations in medicine with Dr. Jeffrey Golden of Cedars-Sinai, and how blockchain works and the basics of cryptocurrencies with BFSG’s own Steven Yamshon, PhD, and team. Check out how fun and informative the forum was by watching a short 3-minute video here. We look forward to seeing you again in 2023!