Grumpus the Story Teller

If you are one of my three avid readers, then you may have wondered if I was ever going regale you with more (true) stories about my rather substantial money mistakes.  Well wonder no more, the time has come.  And while this story does not have the “I sold 300 shares of Amazon in 2004 to buy a house in the height of the market in Southern California” hook that An Unintentional Meander Up Grumpy Avenue Part 1 did; it does have an otherwise avoidable $20,000 dollar tax bill waiting at the end of it.  Not as memorable as my $750,000 opportunity cost?  Fair enough, that sum still makes me light-headed.  However, what if I told you I paid someone for the privilege of the $20,000  tax bill?  And it was potentially avoidable?  Stick with me and by the end of the story if you are not busting out the tried and true “Man that Grumpus is an idiot” line, then I promise you a full refund on your time and a beer next time we meet.

Grumpus The Planner

Prior to deploying to Afghanistan in 2012, I consolidated Mrs. Grumpus’s and my investments with a wealth manager “just in case” something happened to me while I was deployed.  Despite my already long financial journey up to that point (as relayed in Part 1 of this series) I still did not know much about personal finance.  I had not taken the time to read a book, conduct anything more than a cursory search of the Googles, or done anything other than avidly read the Economist magazine.  Terms like Fiduciary or Certified Financial Planner (CFP) were not in my lexicon.  And I certainly hadn’t read this list of 10 questions to ask a prospective financial advisor.

Up to that point, I remained a DIY investor and was only just beyond my awful phase of individual stock picking.  When this deployment came down the pipe, I had barely moved-on to the idea of target date funds for vehicles like our Roth IRAs and Mrs. Grumpus’s 401K.  Furthermore, while I had been itching for several years to consolidate Mrs. Grumpus’s and my accounts under a unified investment strategy, I hadn’t.  I naively thought I needed a professional to build my strategy and consolidate our investments.  All of that sounded like a lot of work, and since I was a new father, there was always an excuse.

Thus, the deployment proved to be the prompt I needed to get off my proverbial ass and get our money in one sock.  If something were to happen to me, my wife (who was also pregnant at the time) was not going to be able to cope.  Ultimately, I knew it was going to cost me some amount of money, but at that point in my life, I needed the peace of mind knowing the money would be handled if the worst happened.  I thought I was making the smart move.

Now, to give the Ghost of Grumpus Past (me) a little credit, as we were going through the series of introductory meetings with our wealth manager, I made sure our tax accountant was there.  Although I did not relay it in Part 1 of this series, I had learned a tax lesson about capital gains when I sold my stocks to accumulate the down payment for our house — that now infamous $750,000 opportunity cost of a mistake.  Also, amazingly, I still had a few original stocks left from my wrongful injury lawsuit money (as explained in Part 1).  I am shocked too!  I can’t believe that Grumpus the Day Trader did not figure out a way to squander those positions!  Yet, there they were, GE and WALMART, sitting there after 20+ years of stock splits and share price appreciation.   Now just to manage expectations,  I am (only) talking about $100,000 in value.  However, I just looked at my Quicken files, and from what I can tell that was from an initial investment of $22,000.  Thus, we were talking about $78,000 in long-term capital gains.

Grumpus the (non) Communicator

My accountant and wealth manager worked in the same office, and I assumed they would communicate about Mrs. Grumpus’s and my circumstances outside the meetings.  What I did not know at the time was that the accountant was in the process of separating his practice (is that what accountants call their business?) from the wealth manager’s. Thus, when I thought they were talking, it actually turned out they were splitting up.  Oddly enough it was an amicable split, done purely for business reasons.  It might as well have been the most bitter business divorce on the face of the earth though, due to the effect it had on my situation.

I did not understand it then, and only understand now after years of educating myself on personal finances, but the wealth manager had no incentive to communicate with my tax accountant.  The wealth manager’s business model was to charge 1% of Assets Under Management (AUM) annually.  Mrs. Grumpus and I had managed to accumulate almost $500,000 between our various accounts, which meant the manager would get $5,000.  Typically the way it works is that you liquidate (sell) all your holdings in your various accounts, roll those accounts into the same type of accounts (ie. a Roth IRA rolled over to Roth IRA) under the management company, and then they purchase mutual funds with a company affiliated to that manager.  In this case, it was a company called SEI, whose management fees within their mutual funds were not overly excessive, but they were not rock bottom either.

In any case, the sooner our wealth manager got those assets under his management, the better, from his perspective.  It was a pay day for him after all.  Granted he did exactly what I asked, unified all our accounts under one central management strategy.  He sat and listened to our desires, plans and fears; and then designed a portfolio to suit our risk tolerance.  He did not try to sell us useless insurance products like annuities.  He also did some other  useful things like advising us on the need for a trust, wills, etc.  It was all an extremely normal, and otherwise pleasant experience.

However, what he failed to advise us about (either through omission or commission) were the tax implications of selling off all my individual stocks in my taxable account at once.  I generally knew there would be some capital gains, but I had no idea of all the implications, or that there was a smarter way to consolidate the funds than simply selling them off in one shot.  That is what I thought I was paying him and my accountant to figure out.  So when the wealth manager contacted me and said it was time to sell my stock, I thought he and my tax accountant had figured out some sort of tax magic.  I stupidly obliged without question.  And like that, I racked up $20,000 tax bill for the following April.  I just did not realize it yet.

Grumpus Taxus

I hate to do this to all my readers, but I am going to geek out on the tax implications of capital gains for a few paragraphs.  For those of you uninterested in the intricacies of my error, and more interested in what I should have done, you can skip to the next section.  Those of you who are interested in the impact of the tax code on this situation, please read on.

Under current tax law, and 2012 law for that matter, there are two types of capital gains: short-term (owned less than a year) and long-term (owned greater than a year).  In my instance, we are talking about long-term capital gains.  Confusingly enough, long-term capital gains are taxed at a flat rate determined by your marginal tax bracket, which lags your marginal tax bracket by one or two tax brackets.  Thus, if you are in the 10 or 15% marginal tax brackets then you pay 0% long-term capital gains; if you are in the 25% to 35% marginal tax brackets then you pay 15%; if you are in the 39.5% tax bracket then you pay 20%.  However, and this is important to note, your long-term capital gains also count as income, which means they could push you into a higher tax bracket when added to your other income.  If that happens then they are also taxed progressively — meaning some are taxed at the lower rate and the remainder are taxed at the higher rate.

Think of it as a bucket.  If you are in the 15% marginal tax bracket bucket with your normal income, and it is only half-full, then you can fill the rest of the bucket with long-term capital gains and a 0% tax rate on those gains.  However, any long-term capital gains that overflow the top of your 15% tax bucket, flows over into the 25% marginal tax bracket’s bucket and is therefore taxed at the 15% long-term capital gains rate.  An example:

Pretend my wife and I normally have an Adjusted Gross Income (AGI) of $65,000 that places us in the 15% marginal tax bracket.  For purposes of this example, let’s say the crossover point from the 15% to 25 % marginal tax bracket is $75,000.  Then let’s say we sold some stocks we held for a total long-term capital gain of $20,000.  The first $10,000 would be taxed at %0, which is the long-term capital gain tax rate for the 15% marginal tax bracket.  But since the second $10,000 puts us into the 25% marginal tax bracket, that money will be taxed at 15%, the long-term capital gains tax rate for those in the 25% marginal tax bracket.

Confused?  Imagine how I felt when I returned home in April 2013 from Afghanistan only to find that tax bill waiting for me.  The $78,000 I earned in capital gains was more than enough to push us from the 15% into the 25% marginal tax bracket for 2012.  Thus the majority of that money was taxed at the federal 15% long-term capital gains.  The same scenario played out at the state tax level too.  All in all, it ended up costing me about $20K in taxes.  Since deployments in combat zones mean your wages are tax-free, returning personnel usually come home to bank accounts full of extra money.  Financially savvy personnel have a plan to use that money for some sort of Roth investment (tax-free in, tax-free out).  I was yet to count myself as savvy, but I had planned on investing that money some way.  Instead, I got to write Uncle Sam and the Bear Republic separate, but fat, tax checks.  Adios deployment money, I miss you so.

Grumpus Should’ve Done This

As it turns out most of the consolidation of our accounts took place during the late fall of 2012, just prior to my deployment.  The smart tax move for the $100,000 in GE and WALMART stock would have been to split the sale of the stock over the end of 2012 and some point in 2013.  As explained above, the difference between your AGI and the ceiling of the marginal tax bracket your AGI places you in, allows for long-term capital gains to fill up to the maximum of that tax bracket, prior to pushing you into the next marginal and long-term capital gains tax bracket.  Thus, had I split the stock sale over two tax years, I could have twice refilled the gap between my AGI in the 15% tax bracket and the cross over point into 25%.  That would’ve saved some money right there.

Furthermore,  due to my deployment, I had tax free months in both 2012 and 2013.  I had more in 2013 actually than 2012, which means I had more capability to absorb those capital gains into the 15% marginal tax bracket prior to pushing me into the 25% tax bracket.  All of the 2013 absorption ability  went wasted by selling everything in 2012.  I could’ve even waited until after I got home to sell the stock in 2013 since it was all part of the same tax year, it did not matter when I sold the stock in 2013.

Now, let’s look at it from the wealth manager’s perspective.  Assuming I split the stock sales over two tax years 50/50 that would have meant $50K less under his management, and therefore $500 dollars less to charge me annually.  Now do I think that crossed his mind in this specific instance?  Probably not.  My point is that his entire business model was set up to incentivize placing as many assets under his management as quickly as possible, so he probably never gave complicated tax considerations like the one described above a second thought.   It was in his best interest to ignore those things, but it was not in my best interest.

Was this guy a Fiduciary?  Meaning did he have a legal obligation to look out for my best interest?  I don’t know, and to tell you the truth it does not matter now.  Even if he was a Fiduciary, he didn’t look out for my best interests, which means what, I could have sued him?  That wasn’t going to happen.  I returned home from Afghanistan to my thankless job in the US  just in time to transfer to Europe with the family.  We had lost the pregnancy at the beginning of my deployment, and the unit I was assigned to lost some guys during deployment.  Stack that on top of some of my previous deployment experiences, and needless to say, I was having trouble coping.  I didn’t know it, but my PTS was already setting in.  My family needed me, and I was barely capable of effecting the move to Europe, let alone initiate legal proceedings over a topic I knew nothing about.

What I took away from the whole episode is this: when it comes to money, absolutely no one looks after your best interests better than you.  Speaking of which, some of you are probably wondering if I fired the wealth manager?  I eventually let him go and went back managing my own investments.  It took a while though.  August 2014 to be exact.  And while the $20K tax bill played a part in my decision, it was the idea of continuing to pay him the AUM fees that prompted me to act.  This time though, I was acting from a much more informed place.  I had taken time in the intervening year to start my personal finance education process (as partly retold in my Grumpus Maximus vs. The Golden Albatross post).  You can damn well bet that I did not simply eliminate all the holdings in my taxable account in one shot.  Instead, I sold the losers and chose to piece-meal the sales of the winners over time in a tax efficient manner.  In fact, I am still doing it.  Who says you can’t teach an old Grump new tricks?

Grumpus, You Want Me to Throw That on Your Tab?

Obviously, I should have talked to my tax accountant prior to selling anything in 2012.  I didn’t because I assumed he and the wealth manager were in the same office and talking.  They weren’t, and that is my fault for assuming.  What did it cost me?  Well, as already discussed there was the $20K tax bill.  But those who’ve read Part 1 of this series know that I like calculating opportunity cost as well.  Opportunity cost is what your money could have been doing if you had not spent it, or given it to the tax man in this case.  For purposes of this story, let’s just say I would have been able to split that $20K bill in half by selling over two tax years, instead of one.  I could have probably saved more, but $10K makes for easy math.  Again for purposes of this argument, let’s say I simply threw the money into an SP 500 index fund.  $10,000 invested in April 2013 would have netted me $16,472.06 today.  Certainly nothing as staggering as the  $750K opportunity cost of purchasing my house, but nothing to laugh at either.

For everyone keeping track at home, that is two major money mistakes in my life which cost me $766.5K total.  How does that feel?  Well, it sucks honestly.  It feels like I am winning a race no one wants to run.  It’s a wonder Mrs. Grumpus and I have any money left at all.  Surviving my money mistakes ought to be the next topic I write about in this series.  But for now, I am going to go sit in the corner and stew while you figure out if I owe you that beer.