The recently passed American Rescue Plan (ARP) Act of 2021 includes a provision making nearly all student loan forgiveness tax-free, at least temporarily. Before the ARP, student loan forgiveness was tax-free only under special programs. Before we look at the changes to come under the ARP, let’s look back at what the previous law provided.
The Old Rules
Under the earlier measure, student loan forgiveness was tax-free under certain circumstances. These special programs included working in certain public sectors, some types of teachers as well as some programs for nurses, doctors, veterinarians, etc. Essentially, you had to work in a specific field under certain conditions for a minimum length of time and some or all your student loans would be forgiven or discharged. There are also other technical qualifications, such as death and disability, closed school, or false certification discharges, but these aren’t widely applicable.
Because student loans are not dischargeable in bankruptcy, income-driven repayment plans were the other main type of program that could result in forgiveness or discharge. Typically, borrowers repaid an amount indexed to their income over a 20-to 25-year period; whatever was leftover at the end was discharged. The forgiven loan amounts under income-driven repayment programs were considered a discharge of indebtedness and tax as ordinary income (although there are exclusions for insolvent taxpayers).
The New Rules
Under the new law in the ARP, the forgiveness of all federal student and parent loans are tax-free. This includes Direct Loans, Family Federal Education Loans (FFEL), Perkins Loans, and federal consolidation loans. Additionally, non-federal loans such as state education loans, institutional loans direct from colleges and universities, and even private student loans also qualify.
The essential criteria for the loan discharge to qualify for tax-free treatment is that it must have been made expressly for post-secondary educational expenses and be insured or guaranteed by the federal government (this includes federal agencies).
This all means that the debt discharged under income-driven forgiveness programs will now be tax-free as well, but there’s a catch. The discharge of student loan debt needs to happen within the next five years because the provision expires at the end of 2025. There could be an extension, but that’s uncertain now.
Why this Change May Really Matter
The change in rules making income-driven student loan forgiveness tax-free isn’t a huge deal for most people. The new law really matters because it sets the stage for broader student loan forgiveness. The program currently being floated by President Biden to forgive $10,000 in student loan debt or the even larger $50,000 proposal by some Senate Democrats will qualify for tax-free treatment.
The majority of U.S. industrial product company CFOs have shared concerns that COVID-19 would impact their businesses negatively. For companies that develop and manufacture products, understanding the product lifecycle and how to work around crises like the COVID-19 pandemic can be effective to help improve the longevity and success of companies.
Market Development Stage
According to the Harvard Business Review (HBR), the first stage of the product lifecycle is market development. This normally happens when a company introduces a new product for sale. There is usually little demand at this point; instead, demand has to be cultivated among consumers.
Factors that impact the rate of introduction include the product’s novelty; how practical it is for consumers’ existing problems; and how the new product impacts the demand of existing products. For example, if there’s a proven cure for a chronic medical condition, the product would have a more effective ability to penetrate the market versus an unproven product – be it a medical device, cell phone, etc.
Market Growth Stage
HBR calls the second stage the market growth stage or takeoff stage. When a product is successful, it enters this stage because demand begins to grow exponentially due to consumers expressing interest in the new product.
From there, competitors looking to leverage the “used apple policy” will produce either knock-offs or improved versions of the new product. Businesses competing in this product category begin standing apart – via their product and/or brand. Ongoing adaptation is fluid and contingent based on what competitors are doing, normally through balancing pricing or optimizing distribution channels.
Market Maturity Stage
This stage sees equilibrium in consumer demand. The best way to understand when this is achieved is when the target demographics are consuming the intended products. Competing companies will focus on standing out in the market by providing niche solutions through customer service, comprehensive warranties, etc. Producers are maintaining relationships with distribution outlets for in-store product promotion and shelf space; also, more favorable distribution agreements normally occur during this stage.
Market Decline Stage
This stage is evident when consumers fall out of love with an item and stop buying it. As too much capacity for the product floods the market and fewer and fewer producers survive, businesses might propose mergers for survival.
Ways to Extend the Product Lifecycle
While the Covid-19 pandemic has taught everyone how to live and work as safely as possible, it’s also shown that businesses need to be constantly reviewing how they can make their product lifecycles more agile.
One way to extend the product lifecycle for a new product is by creating a positive, memorable first impression. An unfavorable first experience might create negative repercussions beyond what would be normal.
For example, how the product was delivered to the customer can make an impact on the customer’s experience. HBR gives the example of companies that produce home appliances. If a small, independent network of family-run appliance stores can deliver white glove service for customers (going above and beyond to make a lasting, positive first impression, including implementing COVID-19 safe practices), they can make a positive first impression. This will increase the likelihood of customers wanting to share their good experience with others.
However, when it comes to merchandising the product, using a more segmented distribution channel via independent appliance stores will take a lot more effort compared to larger, corporate resellers with turnkey distribution capabilities.
Another way, especially to be mindful of COVID-19 safety precautions, is to remove the chance for miscommunication. When working remotely and using chat and/or video conferencing tools, it is important to document all processes, including sample layouts and designs, to ensure different departments are on the same page.
Staying in communication with existing and potential clients is crucial for product launches – either new or enhanced versions. Looking at the next 90 days ahead, evaluate how each customer’s business is doing – are they fighting for survival or is it nearly business as usual? If a customer is all-hands-on-deck to get cashflow to stay in business, it might not be the right time for deployment. But if the new product or enhancement can increase efficiency, it might be right to contact them ASAP.
While every product lifecycle is unique, taking steps to become more nimble can potentially make the difference between a company surviving or thriving during a crisis.
As the January 2021 World Bank Pink Sheet documented, prices increased month-over-month from November 2020 to December 2020. Highlights include the price of oil jumping by 15 percent. The cost of fertilizer jumped 2.2 percent, grains increased by 3.8 percent and iron ore jumped by 25 percent. While there’s been no official “commodity super-cycle,” according to economists or financial analysts, the trend certainly shows commodity prices increasing.
2020 caught the world off-guard with the coronavirus pandemic, sending the price of oil negative. According to Rice University’s Baker Institute for Public Policy, on April 20, 2020, “the prompt contract price” or how much a barrel of West Texas Intermediate (WTI) cost for May 2020 deliveries went negative, falling $50. It eventually rebounded to $45 per barrel in November as vaccine optimism began to take hold.
For other commodities, the story was not as bad, signaling what might be another commodity super-cycle. On Aug. 4, 2020, gold broke the $2,000 mark. With central banks and governments spending to support the economy due to the pandemic, it put pressure on global currencies. For example, with the U.S. dollar index dropping nearly 10 percent from March 2020 to August 2020, precious metals such as gold became a hedge against inflation.
Many would assume that commodities surged in part from the economic damage of COVID-19 but, looking at the data, commodities were seeing a resurgence at the start of 2020 – well before the pandemic negatively impacted the global economy.
With data as recent as March 5, the International Monetary Fund shows how commodities changed before the pandemic, during, and as the recovery is underway for the first two months of 2021. Looking at the IMF’s “Actual Market Prices for Non-Fuel and Fuel Commodities” chart, one can see how commodities bottomed out during the pandemic and are showing signs of significant growth.
One metric ton of wheat was $186.10 in 2018, $163.30 in 2019, $185.50 in 2020. In Q1 of 2020, it was $173.80, Q2 was $174.80, Q3 was $183.00, Q4 of 2020 was $210.5. Then the first two months of 2021, one metric ton of wheat was $237.90 and $240.80, respectively.
For metals, one metric ton of copper was $6,529.80 in 2018, $6,010.10 in 2019, $6,174.60 in 2020. In Q1 of 2020, it was $5,633.90, Q2 was $5,350.80, Q3 was $6,528.60, Q4 of 2020 was $7,185.0. The first two months of 2021, the price was $7,972.10 and $8,470.90, respectively.
Spot Crude priced per barrel in U.S. dollars was $68.30 in 2018, $61.40 in 2019, $41.30 in 2020. In Q1 of 2020, it was $49.10, Q2 was $30.30, Q3 was $42.00, and Q4 of 2020 was $43.70. Then the first two months of 2021, Spot Crude was $53.50 and $60.50, respectively.
For the Spot Crude figures, the IMF uses the Average Petroleum Spot Price (APSP), which averages equally three crudes: West Texas Intermediate, Dubai, and Brent.
Will China Lead the Globe’s Super-Cycle?
As the United Nations defines it, a super-cycle is when there’s a paradigm shift toward increased demand, lasting at least a decade and up to 35 years “in a wide range of base material prices.” It focuses on “industrial production and urban development of an emerging economy.”
Looking at China could signal what the globe will follow economically. According to Refinitiv, China saw a positive growth of 2.3 percent of its GDP in 2020, compared to the global average of -3.5 percent. As the world emerges from the pandemic, it will undoubtedly consume more commodities. When it comes to 2021 GDP expectations for China, the World Bank expects the country to grow by 8 percent to 9 percent.
Looking forward to 2022, Eikon predicts that China’s GDP will grow by 1.6 percent more than the rest of the world, and 3.1 percent higher than America’s GDP expected growth rate in 2022.
Much like the pandemic was not in anyone’s economic forecast, if the global economy is in a commodity super-cycle, savvy investors will be ahead of the curve if a super-cycle materializes.
In 2020, a year when all income brackets benefited from lower tax rates, the stock market took a nosedive at the beginning of the pandemic. For investors sharp enough to see the opportunity, this was an ideal time to convert a traditional IRA into a Roth IRA.
When you conduct a Roth conversion, the assets are taxed at ordinary income tax rates in the year of the conversion. So, the best time to do this is when your current income tax rate is low and when your IRA account balance loses money due to declining market performance. Once you convert the account to a Roth, those assets continue to grow tax free and are no longer subject to taxes when withdrawn later.
If you believe those stocks will rebound, you can direct the traditional and new Roth IRA custodians to move the shares as they are, rather than selling them for cash. Or, if you are converting the entire account and choose to remain with the same brokerage, you can simply instruct the custodian to change the account type. This way you can keep the same investments, pay applicable taxes on the account balance at the time of the conversion, and then never have to pay taxes on future gains.
While the stock market did recover in 2020, many market analysts believe equities are currently overpriced and could experience another correction this year. On top of that, with Democrats now in control of the White House and both houses of Congress, many expect legislation that will increase income taxes, at least among wealthier households.
Therefore, in order to avoid higher taxes on a long-accumulated traditional IRA, 2021 might be a good year to conduct a Roth conversion. The key is to try to time that conversion with a market loss. By conducting a conversion before income taxes increase, you’ll pay a lower rate, and all future earnings can grow tax-free and be distributed tax-free. Bear in mind, too, that a Roth does not mandate required minimum distributions at any age. The full account balance of a Roth has the opportunity to continue growing for the rest of the owner’s life.
A Roth conversion is not the best strategy for everyone. Consider the following scenarios that are not ideal for conversion.
- An investor under age 59½ will be assessed a penalty on newly converted Roth funds withdrawn in less than five years, so this might not work for an early retiree who needs immediate income.
- If you expect to be in a lower tax bracket during retirement, you should wait until then to pay taxes on distributions of your traditional IRA. Also, if you think you might relocate to a state with lower or no state income tax during retirement, not converting eliminates state taxes on that money entirely.
- Watch out for a bump in income taxes on a Roth conversion. You might not want to convert if those assets put you in a higher tax bracket during the year of conversion.
- Also note that if you convert after age 65, higher income reported that year could increase premiums for Medicare Part B benefits, as well as taxes on Social Security benefits.
- If the non-spousal IRA beneficiary is likely to remain in a lower tax bracket than the owner, he might as well leave the assets in the traditional IRA. Otherwise, the owner will waste more of his estate’s assets to pay taxes on the conversion.
- If you don’t have available cash outside the traditional IRA to pay the taxes on the conversion, the money will come out of the account and substantially drop the value. Consider whether or not your investment timeline is long enough to make up for that loss.
- If your goal is to leave that IRA money to a charity, don’t bother to convert. Qualified charities are exempt from taxes on donations.
If you’re planning to leave a Roth IRA to your heirs, they also enjoy tax-free distributions as long as that Roth was opened and funded for at least five years before you pass away. This is another reason why it might be better to convert to a Roth IRA sooner rather than later.
What if you could save enough for your child to go to college debt-free? It might sound impossible, but with dedication, hard work, and careful planning, you can do just that. According to Dave Ramsey, American personal finance advisor, here are the top three tax-favored plans to get started.
The Education Savings Account (ESA)
Otherwise known as the Education IRA, this plan allows you to save $2,000 (after tax) per year, per child. Let’s do that math. If you begin saving when your child is born and put away $2,000 a year until they’re 18, you’ll be investing $36,000. Not too shabby. And the good news is that qualified distributions are tax-free, which means you won’t have to pay anything when you withdraw the funds to pay for college. The other upside is, depending on the rate of growth, you’ll earn more than you would in a regular savings account. However, there are some caveats. You can’t contribute if you make more than $110,000 (single) or $220,000 (married filing jointly); the contribution cap is $2,000 a year; and the money must be used by the time your child is 30.
The 529 Plan
If you want to save more for your child’s education or you don’t qualify for the income limits of the ESA, then this might be a better fit because you can contribute up to $300,000, depending on what state you live in. Ramsey recommends you look for a 529 Plan that allows you to choose your investment funds. Also, he says most of the time there aren’t any income restrictions based on your child’s age; however, there are some limits, so choose wisely. This plan also grows tax-free. One thing to note: restrictions may apply if you want to transfer your funds to another child.
The UTMA or UGMA (Uniform Transfer/Gift to Minors Act)
One of the best things about these plans is they’re not just designed to save for education. For example, if your kiddo wants to take a gap year, this can cover living expenses. The account is set up in your child’s name but it’s controlled by a custodian (usually a parent or grandparent). The custodian manages the account until the child is 21 (18 for the UGMA). One of the pluses of this plan is that since the account is owned by the child, the earnings are usually taxed at the child’s rate, which is generally lower than that of the parents. For some people, the savings can be significant. However, there are two important things to know: (1) once your child is of legal age, she can use the funds however she likes (a trip to Europe, a sports car…or college?) and, (2) the beneficiary can’t be changed after selected.
While setting up a college fund is a smart goal, it’s not the only one. Prior to starting down these paths, Ramsey recommends that you consider paying off your mortgage, credit cards, and your own student loans. He also suggests setting up an emergency fund of three to six months and allocating 15 percent of your salary to retirement through a 401(k) and/or a Roth IRA. For more help, he recommends both parents and children read “Debt-Free Degree.” This book walks you through how to go to college without student loans.
Saving for an education might feel completely overwhelming, but if you start early enough, do your homework and create a solid plan, it’s absolutely possible.