Many members of the “sandwich generation”–a group loosely defined as people in their 40s to 60s who are “sandwiched” between caring for their own children and aging parents–find themselves in the position of raising a family and looking after the needs of aging parents. If the time has come when you and your parents think that it may be in their best interest to live with you, you should discuss the implications and how it will impact your entire family.

 

Your first topic should be to have all your family members share their expectations for living together. No doubt your parents will want to feel part of your household. However, you’ll want to know how much they want to participate in day-to-day activities in your home. For example, if able, would they be willing to take on some responsibilities, such as babysitting and transporting kids to school or other activities? Will they participate in other family activities, such as meals and social events?

 

Next, consider whether your home can properly accommodate your parents. Do you have adequate privacy/space for your parents, or will you need to remodel or renovate an existing area of your home? Will your parents be able to move around your home easily, or do you need to install appropriate safety devices? Common modifications and repairs for aging family members may include grab bars in bathrooms, an automatic chair lift for stairs, and a ramp for wheelchair access.

 

You will also need to explore the financial impact. Will your parents contribute to household expenses, or will you cover their portion? Do they have enough money to help support themselves during their retirement? If not, will you be able to support them financially?

 

While having multiple generations living together in the same home can be a rewarding experience, it can also be challenging at times. As a result, it’s important to keep the lines of communication open between you, your spouse, your children, and your parents. Doing so can help ensure a happy and healthy home environment for your entire multigenerational family.

 

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It’s been around since 2013, but many are still struggling to come to grips with the net investment income tax. The 3.8% tax, which is sometimes referred to as the Medicare surtax on net investment income, affected approximately 3.1 million federal income tax returns for 2013 (the only year for which data is available) to the tune of almost $11.7 billion.1 Here’s what you need to know.

 

What is it?

 

The net investment income tax is a 3.8% “extra” tax that applies to certain investment income in addition to any other income tax due. Whether you’re subject to the tax depends on two general factors: the amount of your modified adjusted gross income for the year, and how much net investment income you have.

 

Note: Nonresident aliens are not subject to the net investment income tax.

 

What income thresholds apply?

 

Modified adjusted gross income (MAGI) is basically adjusted gross income–the amount that shows up on line 37 of your IRS Form 1040–with certain amounts excluded from income added back in.

 

The net investment income tax applies only if your modified adjusted gross income exceeds the following thresholds:

filing-magi

 

What is net investment income?

 

Investment income generally includes interest, dividends, capital gains, rental and royalty income, income from nonqualified annuities, and income from passive business activities and businesses engaged in the trade of financial instruments or commodities. Investment income does not include wages, unemployment compensation, Social Security benefits, tax-exempt interest, self-employment income, or distributions from most qualified retirement plans and IRAs.

 

Note: Even though items like wages and retirement plan distributions aren’t included in net investment income, they are obviously a factor in calculating MAGI. So higher levels of non-investment income can still make a difference in whether the net investment income tax applies.

 

Gain from the sale of a personal residence would generally be included in determining investment income. However, investment income does not include any amount of gain that is excluded from gross income for regular income tax purposes. Qualifying individuals are generally able to exclude the first $250,000–or $500,000 for married couples filing jointly–of gain on the sale of a principal residence; any of the gain that’s excluded for regular income tax purposes would not be included in determining investment income.

 

To calculate net investment income, you reduce your gross investment income by any deductible expenses that can be allocated to the income. So, for example, associated investment interest expense, investment and brokerage fees, expenses associated with rental and royalty income, and state and local income taxes can all be factored in.

 

How is the tax calculated?

 

You know your modified adjusted gross income. You know your net investment income. To calculate the net investment income tax, first subtract the threshold figure (shown above) for your filing status from your MAGI. Then compare the result with your net investment income. Multiply the lower of the two figures by 3.8%.

 

For example, assume you and your spouse file a joint federal income tax return and have $270,000 in MAGI and $50,000 in net investment income. Your MAGI is $20,000 over the $250,000 threshold for married couples filing jointly. You would owe $760 (3.8% multiplied by $20,000), because the tax is based on the lesser of net investment income or MAGI exceeding the threshold.

 

How is it reported?

 

If you’re subject to the net investment income tax, you must complete IRS Form 8960, Net Investment Income Tax–Individuals, Estates, and Trusts, and attach it to your federal income tax return (you must file IRS Form 1040). The instructions for IRS Form 8960 provide an overview of the rules that apply and can be a good source of additional information. If you think you may be affected by the net investment income tax, though, it’s a good idea to consider discussing your individual situation with a tax professional.

 

  1.  IRS Statistics of Income Bulletin, Spring 2015

In an ideal world, your retirement would be timed perfectly. You would be ready to leave the workforce, your debt would be paid off, and your nest egg would be large enough to provide a comfortable retirement–with some left over to leave a legacy for your heirs.

 

Unfortunately, this is not a perfect world, and events can take you by surprise. In a survey conducted by the Employee Benefit Research Institute, only 44% of current retirees said they retired when they had planned; 46% retired earlier, many for reasons beyond their control.1 But even if you retire on schedule and have other pieces of the retirement puzzle in place, you cannot predict the stock market. What if you retire during a market downturn?

 

Sequencing risk

 

The risk of experiencing poor investment performance at the wrong time is called sequencing risk or sequence of returns risk. All investments are subject to market fluctuation, risk, and loss of principal–and you can expect the market to rise and fall throughout your retirement. However, market losses on the front end of your retirement could have an outsized effect on the income you might receive from your portfolio.

 

If the market drops sharply before your planned retirement date, you may have to decide between retiring with a smaller portfolio or working longer to rebuild your assets. If a big drop comes early in retirement, you may have to sell investments during the downswing, depleting assets more quickly than if you had waited and reducing your portfolio’s potential to benefit when the market turns upward.

 

Dividing your portfolio

 

One strategy that may help address sequencing risk is to allocate your portfolio into three different buckets that reflect the needs, risk level, and growth potential of three retirement phases.

 

Short-term (first 2 to 3 years): Assets such as cash and cash alternatives that you could draw on regardless of market conditions.

Mid-term (3 to 10 years in the future): Mostly fixed-income securities that may have moderate growth potential with low or moderate volatility. You might also have some equities in this bucket.

Long-term (more than 10 years in the future): Primarily growth-oriented investments such as stocks that might be more volatile but have higher growth potential over the long term.

 

Throughout your retirement, you can periodically move assets from the long-term bucket to the other two buckets so you continue to have short-term and mid-term funds available. This enables you to take a more strategic approach in choosing appropriate times to buy or sell assets. Although you will always need assets in the short-term bucket, you can monitor performance in your mid-term and long-term buckets and shift assets based on changing circumstances and longer-term market cycles.

 

If this strategy appeals to you, consider restructuring your portfolio before you retire so you can choose appropriate times to adjust your investments.

 

Determining withdrawals

 

The three-part allocation strategy may help mitigate the effects of a down market by spreading risk over a longer period of time, but it does not help determine how much to withdraw from your savings each year. The amount you withdraw will directly affect how long your savings might last under any market conditions, but it is especially critical in volatile markets.

 

One common rule of thumb is the so-called 4% rule. According to this strategy, you initially withdraw 4% of your portfolio, increasing the amount annually to account for inflation. Some experts consider this approach to be too aggressive–you might withdraw less depending on your personal situation and market performance, or more if you receive large market gains.

 

Another strategy, sometimes called the endowment method, automatically adjusts for market performance. Like the 4% rule, the endowment method begins with an initial withdrawal of a fixed percentage, typically 3% to 5%. In subsequent years, the same fixed percentage is applied to the remaining assets, so the actual withdrawal amount may go up or down depending on previous withdrawals and market performance.

 

A modified endowment method applies a ceiling and/or a floor to the change in your withdrawal amount. You still base your withdrawals on a fixed percentage of the remaining assets, but you limit any increase or decrease from the prior year’s withdrawal amount. This could help prevent you from withdrawing too much after a good market year, while maintaining a relatively steady income after a down market year.

 

Note: Asset allocation is a method used to help manage investment risk; it does not guarantee a profit or protect against investment loss.

 

  1. Employee Benefit Research Institute, “2016 Retirement Confidence Survey”

 

In 1981, the Nobel Prize-winning economist Robert Shiller published a groundbreaking study that contradicted a prevailing theory that markets are always efficient. If they were, stock prices would generally mirror the growth in earnings and dividends. Shiller’s research showed that stock prices fluctuate more often than changes in companies’ intrinsic valuations (such as dividend yield) would suggest.1

 

Shiller concluded that asset prices sometimes move erratically in the short term simply because investor behavior can be influenced by emotions such as greed and fear. Many investors would agree that it’s sometimes difficult to stay calm and act rationally, especially when unexpected events upset the financial markets.

 

Researchers in the field of behavioral finance have studied how cognitive biases in human thinking can affect investor behavior. Understanding the influence of human nature might help you overcome these common psychological traps.

 

Herd mentality

 

Individuals may be convinced by their peers to follow trends, even if it’s not in their own best interests. Shiller proposed that human psychology is the reason that “bubbles” form in asset markets. Investor enthusiasm (“irrational exuberance”) and a herd mentality can create excessive demand for “hot” investments. Investors often chase returns and drive up prices until they become very expensive relative to long-term values.

 

Past performance, however, does not guarantee future results, and bubbles eventually burst. Investors who follow the crowd guarantee future results, and bubbles eventually burst. Investors who follow the crowd can harm long-term portfolio returns by fleeing the stock market after it falls and/or waiting too long (until prices have already risen) to reinvest.

 

Availability bias

 

This mental shortcut leads people to base judgments on examples that immediately come to mind, rather than examining alternatives. It may cause you to misperceive the likelihood or frequency of events, in the same way that watching a movie about sharks can make it seem more dangerous to swim in the ocean.

 

Confirmation bias

 

People also have a tendency to search out and remember information that confirms, rather than challenges, their current beliefs. If you have a good feeling about a certain investment, you may be likely to ignore critical facts and focus on data that supports your opinion.

 

Overconfidence Individuals

 

often overestimate their skills, knowledge, and ability to predict probable outcomes. When it comes to investing, overconfidence may cause you to trade excessively and/or downplay potential risks.

 

Loss aversion

 

Research shows that investors tend to dislike losses much more than they enjoy gains, so it can actually be painful to deal with financial losses.2 Consequently, you might avoid selling an investment that would realize a loss even though the sale may be an appropriate course of action. The intense fear of losing money may even be paralyzing.

 

It’s important to slow down the process and try to consider all relevant factors and possible outcomes when making financial decisions. Having a long-term perspective and sticking with a thoughtfully crafted investing strategy may also help you avoid expensive, emotion-driven mistakes.

 

Note: All investments are subject to market fluctuation, risk, and loss of principal. When sold, investments may be worth more or less than their original cost.
1. The Economist, “What’s Wrong with Finance?” May 1, 2015
2. The Wall Street Journal, “Why an Economist Plays Powerball,” January 12, 2016