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How Much Can I Give Per Year Without Having to Pay Tax

Administrative note: There will be no articles this upcoming Friday or Monday, due to the holidays. The regular posting schedule will resume the following Friday (1/2). I hope you all enjoy your holidays!

A reader writes in, asking:

“How much can I give per year without having to pay any tax? I read in one place that it’s $14,000 and in another place that it’s over $5 million.”

First, a quick point of clarification for any readers new to the topic: The recipient of a gift does not have to pay tax on it. It is only the person giving the gift who has to worry about the gift tax.

Excluded Gifts

None of the following types of transfers are subject to the gift tax:

  • Gifts to your spouse,
  • Gifts to a qualifying charity,
  • Gifts to a political organization for its use, and
  • Payments made directly to an educational institution or health care provider to pay for somebody else’s tuition or medical expenses.

In other words, you can give away as much money as you want in any of the above ways, without having to worry about gift tax.

Annual Gift Tax Exclusion

For gifts that don’t fall under any of the above exclusions, you can still give (for 2014 and 2015) up to $14,000 per year without the gift being taxable.

A key point here is that this annual exclusion is per donor, per recipient. In other words, you can give up to $14,000 per year to as many different people as you’d like, without ever exceeding the annual exclusion. And if you’re married, your spouse could also give up to $14,000 to each of those same people without ever exceeding the annual exclusion.*

Lifetime Exclusion

So what happens once you exceed the annual exclusion amount? You’ll have to file Form 709 to report the taxable gift, but in most cases you still won’t have to pay any gift tax. That’s because, after exhausting your annual exclusion, you then have to exhaust your lifetime exclusion before you actually have to pay any gift tax.

For example, if you give $40,000 to your brother in 2015, you will have made a taxable gift of $26,000 (that is, $40,000 minus the $14,000 annual exclusion). This $26,000 amount will come out of your lifetime exclusion.

As of 2014, the lifetime exclusion is $5.34 million (and twice that for married couples). For 2015, the amount is $5.43 million (and twice that for married couples). As you might imagine, most people never have to pay any gift tax, because they never even come close to exceeding their lifetime exclusion.

Of note: The lifetime exclusion is a shared exclusion with the estate tax. (The overall purpose of the gift tax, by the way, is to eliminate the possibility of people simply gifting their assets to their heirs before they die, in order to avoid the estate tax. So a shared exclusion makes sense.) In other words, by making a taxable gift, you reduce the amount that can be left to your heirs before the estate tax kicks in.

*Spouses are also allowed to elect (on Form 706) to have gifts treated as if they were given 50/50 by each spouse. This would be helpful, if, for instance, you have a $20,000 piece of property that you want to give to somebody. If only one spouse gives it (and no special election is made), then there’s a $6,000 taxable gift (assuming a $14,000 annual exclusion). But if a gift-splitting election is made, there would be no taxable gift because a total $28,000 annual exclusion would be available.

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Investing Blog Roundup: Tax Extenders and ABLE Act

As of this week, both houses of Congress have passed the Tax Increase Prevention Act of 2014, which retroactively extends several different tax breaks that had expired at the end of 2013. (Now, they expire at the end of 2014.) Among the extended tax breaks are the exclusion for “qualified charitable distributions” from IRAs, the tuition and fees deduction, and the deduction for teacher classroom expenses.

In addition, Congress passed the Achieving a Better Life Experience (ABLE) Act of 2014, which permanently creates a new type of 529 account in which people can save/invest for the purpose of supporting individuals with disabilities. The new accounts will function similarly to education 529 accounts, with one big difference being that a whole list of expense categories other than just education expenses will be eligible for tax-free distributions.

Michael Kitces has more information on both pieces of legislation:

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Is It Time to Overweight Energy Stocks?

A reader writes in, asking:

“What do you think of an Energy Mutual Fund such as Vanguard’s Energy Fund for a 3-5% position within one’s stock portfolio at this time?

Some investors such as Buffet have suggested that the time to invest in markets when there is “blood in the streets”, and there is crying from obvious pain.  Do you think the rapid price decline of oil and related energy stocks is a good investment through an energy fund, or should one be satisfied with the percentage of energy and related stocks through an S&P 500 fund or total market index fund?  Is there enough pain and blood in this sector to warrant at least a look at an energy fund for a longer term hold of at least one to three years?”

As of 12/12/14, the Vanguard Energy Fund is down just over 30% from the peak it reached in June of this year.

For an investor considering a temporary overweighting of this industry (relative, that is, to the portion of the overall market that it makes up), the question that must be answered is whether this 30% decline is an overreaction, an appropriate reaction, or an underreaction to the decline in oil prices. It would only make sense to overweight this industry if you were convinced that the recent price decline is an overreaction to the news (i.e., share prices have gone down more than they really should have, making today an opportunity to buy at bargain prices).

So, how would you determine whether the price change is an overreaction?

In short, you’d have to do some math (and a lot of research).

Specifically, you’d have to calculate your expectation for the industry’s future earnings given the new lower oil price (which would necessitate, among other things, an estimate of how long the price of oil will stay where it now is). And then you’d have to calculate what you consider to be a fair value of the industry, given those new earnings expectations.

As for me personally, such calculations and estimates would be well beyond the sort of thing I could do with any significant degree of confidence.

But if you don’t actually take the time to do the research and math, all you’re really doing is guessing.

You could make the case that, yes, it’s a guess, but if you make many guesses of this nature over the course of your investing career, you’ll be right more often than not given that investors tend to overreact to news. But there are, in my view, at least three compelling points against such a strategy:

  • Monitoring the news and moving in and out of various funds is quite a bit of work, relative to a simple buy-hold-and-rebalance strategy,
  • It involves higher costs, due to transaction costs and/or owning funds with higher costs than broad-market index funds, and
  • There’s evidence of a “momentum effect” in most equity markets, which might suggest that investors actually tend to underreact to news at first.

Investing Blog Roundup: Vanguard Personal Advisor Services

I read this week that Vanguard’s new “Personal Advisor Services” program (which provides asset management, a basic financial plan, and the ability to contact a CFP with any questions for a cost of 0.3% per year) has been gathering assets more quickly than the start-up companies in the robo-advisor space. Perhaps that shouldn’t be a surprise, given Vanguard’s massive size. But it will be interesting to see how quickly the program grows once Vanguard officially takes it out of the test phase and begins marketing it more broadly.

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Why Does Everybody Recommend Complex Portfolios?

A reader writes in, asking

“On the Bogleheads forum I see people recommending the ‘three fund portfolio’ with Total Stock Market, Total International Stock, and Total Bond Market funds. But I never see something this basic anywhere else. Elsewhere, I see portfolios recommended that include many more funds or articles recommending the new and improved types of index funds. What’s wrong with a normal index fund portfolio? Why doesn’t the three fund portfolio or anything similar get talked about anywhere else?”

To understand this phenomenon, I think it’s helpful to step back and look at an industry trend: Over the last several years, the idea that passive investing is generally preferable to active investing has become the conventional wisdom. Evidence of this trend is all over the place — the massive size of Vanguardthe explosive growth of assets invested in ETFs, or the steadily-rising percentage of equity mutual fund assets that are invested in index funds.

But that new conventional wisdom presents a challenge for many parties: How do we make money?

Mutual fund companies are unlikely to beat Vanguard at their own game. (And most fund companies wouldn’t even want to — there’s not a lot of money to be made by being the rock-bottom-cost provider of a commodity service.) So they need something to sell you other than your basic market-weighted index fund. But they still want to fall under the “passive” umbrella so that they can get all the marketing benefits of being associated with the passive-beats-active conventional wisdom. So now rather than fund companies pushing their actively managed funds, we see many pushing a new breed of fancy-passive funds: smart beta, equal-weight index funds, fundamental index funds, and so on.

And advisors who practice only portfolio management (rather than broader financial planning) have a similar predicament. Passive portfolio management is already available at a very low cost via all-in-one funds (e.g., Vanguard Target Retirement Funds) or via a “robo-advisor” such as Betterment or Wealthfront. Advisors can’t beat those services on cost, so they have to show that they can do something better. In most cases, that means trying to convince you that the portfolio that they will craft for you is better than the portfolio you’d get via one of those less expensive options. And it’s easier to convince you of that if they recommend something that looks very sophisticated.

Now, to be clear, writers (myself included) are faced with the same dilemma. There isn’t that much to say about a boring market-weighted portfolio made of just a few index funds. And there’s even less to say about a portfolio consisting of nothing but an all-in-one fund. And yet we need topics for articles. So you’ll find us writing about a whole list of other investment strategies.

In other words, at least a part of the reason why simple portfolios using traditional index funds don’t get a great deal of discussion is that, in many cases, it’s more profitable to talk about something else.

Investing Blog Roundup: Tips for Taking RMDs

With the end of the year closing in, I enjoyed seeing an article on Vanguard’s website from Maria Bruno (a CFP in their Investment Counseling & Research group) giving several good tips relating to required minimum distributions (RMDs).

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