Category Archives: Financial Planning

Planning for Tax Law Changes – the Investment Piece

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Among the anticipated changes in taxes for individuals are the increase of the long-term capital gains rate from 15% to at least 20% and the elimination of the qualified dividend rate of 15%. How do you respond? That depends on several factors.

If the investments are tax-sheltered, as in an IRA or 401(k) plan, then the change has no impact: current growth is sheltered and withdrawals are always taxed as ordinary income. If the investments are in a taxable account, then the analysis involves your long-term plans and investment style. On the long-term capital gains, if you may be selling investments soon, doing so now and buying back (subject to the wash sale rules, if applicable), would increase your basis so that less would be taxed later at a higher rate. However, if you plan to hold investments long-term, there is little reason to react now. That is, the increased tax far in the future is less, on a net present value basis, than paying a lower tax today.

The long-term capital gains tax is still likely to be less than the maximum marginal rate, so converting what would be earned income into capital gains remains attractive (e.g., the basis for exercising and holding Incentive Stock Options)

As for the dividends tax, again this depends on your investment strategy. If you believe that the proper stocks or funds include those that distribute dividends, then the tax cost is part of your analysis in selecting those investments over funds or stocks that do not pay dividends.

As with any decision regarding the tax impact on investments, it is the investment strategy that should rule the outcome.

We will report more on possible tax changes and related strategies in upcoming newsletter posts.

Let us know if you have questions or comments. Thanks,

Steven

Estate planning – your homework before and after

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Before – what you have to do to get the proper documents executed

Estate planning and the analysis of life insurance connect in the following way, so you want to do the analysis with your financial advisor in order to make sure that the survivors have sufficient resources to maintain the same lifestyle during their life expectancy. The reason that the analysis of life insurance should be done before deciding on what documents you need for your estate plan is that you may choose to increase your death benefit, which could change the size of your potential estate, thereby changing the estate tax planning. That is, if the investable assets are not sufficient, even after making liquid certain kinds of personal property (e.g., a second home), then there is a need for additional life insurance.

In most cases, the type of insurance to be acquired is term insurance. This is merely a death benefit used to fund the shortfall between assets required to maintain the lifestyle of the survivors and actual assets available. Whole life or other types of insurance should only be used when permanent insurance is required, as in the case of maintaining estate liquidity throughout your lifetime.

After you determine the assets required to support the lifestyle of the survivor, you determine to whom the assets flow. For example, you could leave everything directly to the survivor, you could separate some portion of the assets by gift now or at death to go directly to children or you could have a trust control the division of assets as needed over time. Separating assets by gift now would be important if you wanted to ensure some minimum funding for children, such as guaranteeing coverage for their college expenses.

Selection of fiduciaries is next: In determining the final estate plan, many choices revolve around the fiduciary that you select for a particular role. For example, people who typically would have chosen to have all assets flow to the surviving spouse become willing to use trusts when they realize that the person whom they expect to select as trustee will make decisions that they would have made had they survived. The fiduciaries that must be put in place include the following:

a) Executor: This is the person who “marshals” all assets of the estate together, pays death expenses and transfers ownership of property to the surviving spouse or trust. This is approximately a nine month task.

b) Guardian: This is the person whom you select to love and care for your children in your absence. The spouse selects the surviving spouse and then a second or third choice beyond that. This job lasts until each child has reached majority (age eighteen in Massachusetts).

c) Trustee: This person has potentially the longest term job because he or she must manage the trust assets and make distributions of income and sometimes principal to the surviving spouse, children and even grandchildren. Depending on the terms of the trust, this job could last until the children are young adults.

The trustee acts as the owner of assets and manages the investments, taxes and distributions. The trustee can delegate this work, and review what people he or she hires complete for the trust and beneficiaries.

d) Medical representatives and attorneys in fact: you will also want to select people to make medical decisions and manage your finances is you are not able.

After – what you have to do after you have the proper documents executed

Make sure that you update all of your beneficiary designations:

Qualified Plans (IRA’s, 401k plans, etc.): Primary Beneficiary – to the surviving spouse (so he or she can roll over the proceeds to an IRA and thereby defer income taxes); and Secondary Beneficiary – to your children (or your own revocable, depending on whether you want the assets controlled or available to children).

Life Insurance and Annuities: Primary Beneficiary – when not owned by an irrevocable trust, such as group term, to your own revocable trust (for estate tax benefits, e.g., using credit at first death); and Secondary Beneficiary – to the surviving spouse (in case of trust has been terminated for some reason).

Other Assets: Consider changing ownership of any jointly held assets to ownership by one of you. Any assets held as joint tenants with rights of survivorship will go to the survivor by operation of law and never get to your revocable trust. (You want to be sure that you have sufficient assets going to the trust to realize the full tax reduction effect.)

You should also consider compiling a reference book or adding to your financial plan book photocopies of important papers, identifying where the originals are, then adding a list of important contacts, instructions to your executor and trustee and other important notes for family and friends. You would update this at least annually with new asset statements (consider this as you gather information for preparing your taxes). To be more specific, the list (and copies) should include:

* 1. Location of original will, trust, etc.
* 2. Location of health care proxy and durable power of attorney
* 3. List of professionals with contact information: doctor, attorney, CPA, etc.
* 4. List of fiduciaries with contact information: health care proxy, guardians, executors and trustees, attorney-in-fact for durable power of attorney, etc.
* 5. Location of insurance policies and valuables such as original titles, etc.
* 6. Location of safe deposit box for valuables and items in #5 or 7
* 7. List of all bank and investment accounts and location of any stock certificates or other documentation for investments
* 8. List of all mortgages, loans and credit card accounts
* 9. Any appraisals or other listing of items by value
* 10. All automatic debits that need to be addressed (stopped, changed)
* 11. List of all password protected accounts (e-mail, on line banking and credit cards, etc.) and where to locate the passwords… and the password to access the passwords!

Let us know if you have questions or comments. Thanks,

Steven

Identiy Theft – financial planning tips on protecting your computer

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On line usage is up, but so is identity theft.

One example we hear of often is an e-mail purporting to be from the IRS regarding a refund. The IRS has said categorically that they do not send out e-mails, so this is clearly a scam to get personal information.

So, as a financial planning matter, what do to protect your computer and your personal information?

Here are several good tips from WebRoot, a software company that provides related software, worth applying to your computers:

1. Keep Your Security Software Up to Date: At a minimum, your PC should have current antispyware, antivirus and firewall protection.
2. Watch Out for Email Scams: Never click on links sent in unsolicited emails, even if it appears to be from a legitimate source [the IRS example above is but one….].
3. Use Strong, Unique Passwords: Create passwords that are difficult to guess, and use different passwords for each of your accounts.
4. Shop and Bank on Secure Connections: Hackers can intercept data sent over unsecure wireless connections, so exercise caution when performing sensitive online transactions in public places.
5. Erase Cookies: Get in the habit of clearing cookies off your hard drive after you browse the web. Some privacy protection software can automatically do this for you

Be sure you have applied all of the tips to any computer not already protected. And, let me know if you have questions or concerns

Thanks,

Steven

Tax Planning – take the IRA distribution or defer?

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Here is another year-end tax planning issue for people taking the required minimum IRA distributions:

Do you defer as the 2009 law allows or do you take it now because tax rates will be going up?

Input from Kiplingers is reprinted below.

For me the issue is alternate sources of cash flow. If you can defer, even against rising rates, that usually pays off because of the compounding of sheltered growth

However, this depends on how you have invested as well as your cash flow needs so everyone has to review

Thanks,

Steven Contact

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To Tap or Not to Tap Your IRA

You can skip your distribution this year and save on taxes.
By Mary Beth Franklin, Senior Editor, Kiplinger’s Personal Finance
November 25, 2009

If you are at least 70½ years old, you normally must take a taxable distribution from your traditional IRA or employer-provided retirement plan by the end of the year — whether you need the money or not — or face a stiff penalty equal to half of the amount you failed to withdraw. But this year is different. Uncle Sam says you can skip your required minimum distribution for 2009. (Employees who continue working past age 70½ are not subject to mandatory distributions from their company plans until they retire, but they still must take distributions from their IRAs.)

IRA owners who turned 70½ between July 1 and December 31 would normally have to take their first distribution by April 1, 2010. But thanks to the waiver, they can skip that, too, delaying their first mandatory-distribution deadline until December 31, 2010.

Related Links

* The New Roth Rollover Rules

And if you tapped your IRA earlier in the year and now regret it, the usual 60-day rollover period, which allows you to redeposit the money tax- and penalty-free, has been extended to November 30. But there’s a catch: You are allowed to put one IRA withdrawal back into the account within 365 days. So if you received regular distributions every month, for example, then you can put only one of the withdrawals back in. If you received the money in a lump sum, however, then you can put it all back (including any taxes withheld from the distribution; otherwise it will be considered a distribution and will be taxed as ordinary income).

The one-year moratorium on mandatory distributions also applies to owners of inherited IRAs and other retirement accounts. For example, if you inherited your mother’s IRA and planned to take annual distributions based on your own life expectancy, you can forgo this year’s withdrawal. Or if you follow another set of distribution rules that require you to empty an inherited IRA by the end of the fifth year after the owner’s death, you now have an additional year to do so.

Although there are no required minimum distributions for Roth IRA owners — regardless of age — nonspouse beneficiaries who inherit a Roth are subject to the mandatory distributions. They can skip this year’s withdrawal, too.

Of course, you can tap your traditional IRA this year if you wish and pay taxes at your ordinary rate on the entire amount you withdraw. But if you don’t need the money, there are several advantages to skipping a distribution for 2009. Keeping your money invested in a tax-deferred IRA will give your account even more to time to recover from the worst market collapse since the Great Depression. Plus, not taking an IRA distribution this year could reduce the tax bill on your other income. You might be able to trim the amount of your Social Security benefits that are taxed, and with a lower income, you may be eligible for other tax breaks that you normally can’t use, such as deducting medical expenses in excess of 7.5% of your adjusted gross income.

You can still opt to send up to $100,000 of your IRA distribution directly to a charity. While you can’t double-dip and deduct the donation as a charitable contribution, the amount will not be added to your taxable income.

Another option: Because you aren’t required to withdraw the money this year, you may want to roll some of it into a Roth IRA. (See more on Roth IRA choices here.) You’ll have to pay taxes when you make the switch, but you can take tax-free withdrawals after five years, you never have to take required minimum distributions, and you can create a tax-free inheritance for your heirs. You don’t need earned income to convert a traditional IRA to a Roth, but to qualify, your income — not counting converted amounts — can’t top $100,000 in 2009.

Tags: Roth IRAs and Roth 401(k)s Making Your Money Last, Saving for Retirement, Tax Breaks, Tax Planning

Let us know if you have questions or comments. Thanks,

Steven

Estate Planning – will we have a new tax law in time?

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Many people have argued that Congress will freeze the federal estate tax exemption at $3.5 million and the estate tax rate at 45%

The House passed such a law and sent it to the Senate early this month.

However, as described in the article below, passage of this change to current law is not certain as there are political and procedural obstacles in the Senate. (Please see a more recent comment at What to watch out for in 2010)

If no action is taken, then there will be no estate tax in 2010 and only a $1 million exemption in 2011. In the second artilce below, Kiplinger’s Tax Letter projects a 1 year extension of the 2009 law.

We will continue to watch this to see if a law does pass…. and let me know if you have questions or comments. Contact Us

Estate Tax Reform Bill Passes House, Moves to Senate

Posted on December 8, 2009

On Dec. 3, the House passed the Permanent Estate Tax Relief for Families, Farmers, and Small Businesses Act of 2009 (H.R. 4154). With time running short, the bill now moves to the Senate, where straight passage of it is uncertain, and passage of any estate tax legislation is anything but assured.

Introduced by Rep. Earl Pomeroy (D-ND), the legislation permanently extends current estate tax law, which taxes the heirs of a deceased individual whose estate is valued above $3.5 million ($7 million for couples) at a 45 percent tax rate. The Pomeroy bill passed the House by a narrow margin – just 225 to 200 – and mainly along partisan lines, though 26 Democrats did join a united Republican caucus in opposition to the measure. The bill essentially mirrors what the president asked for in his FY 2010 budget request. Most importantly, the Pomeroy bill would extend current law and prevent the estate tax from expiring in 2010 and then coming back in 2011 under its pre-Bush tax cut levels.

According to an estimate released by the Congressional Joint Committee on Taxation, the Pomeroy bill would bring in $468 million in 2010, when the government would otherwise collect no estate taxes, but then cost the government $533 billion over the next nine years because of higher exemptions and lower tax rates than would have been in place if current law was left unchanged.

Passage of the Pomeroy bill in the Senate is unlikely because several important senators have misgivings about certain provisions. Sens. Max Baucus (D-MT) and Kent Conrad (D-ND), chairs of the Senate Finance and Budget Committees, respectively, argue that Congress should index the tax for inflation, something the Pomeroy bill does not do. Moreover, the Pomeroy bill includes the Statutory Pay-As-You-Go Act of 2009 (H.R. 2920) that would give PAYGO budget rules the force of law in Congress. The House passed the PAYGO bill in July, but the Senate has yet to take action on it because, according to a recent Congress Daily (sorry, subscription required to view), top Democratic senators are opposed to enacting the provisions.

Estate tax legislation is therefore likely to go down one of two paths in the Senate. One alternative is for the Senate to bring up legislation similar to the Pomeroy bill, debate it, and pass it. The other option is for the Democratic leadership to tack a one-year estate tax extension onto a likely omnibus appropriations bill that insiders say Congress will pass before the end of 2009. Depending on how congressional events play out, either option is possible.

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Without action by Congress before the end of this year, the estate tax will disappear in 2010, but only for one year. The tax will then reappear in 2011 with just a $1-million exemption and a 55% maximum rate. In addition, many heirs of folks who die in 2010 will have to use the decedent’s tax basis for inherited assets.

The House has OK’d a permanent extension of the law in effect for 2009… a $3.5-million exemption with a 45% rate. Its bill repeals the carryover basis rule.

But the Senate has its own ideas. Finance Com. head Max Baucus (D-MT) favors continuing the $3.5-million exemption and indexing it to inflation each year, while maintaining the 45% rate. A coalition of Republicans and moderate Democrats is pushing for broader relief…a $5-million exemption and a 35% maximum tax rate. They have enough support to demand a vote for their proposal on any estate tax bill, and are likely to keep the Senate from voting on a permanent extension this year.

So a simple one-year extension of 2009 law is the likely result. This way, lawmakers can revisit the estate tax next year, after the health care debate ends. The bill will also kill carryover basis. To speed passage, the Senate may even add it to a fast moving appropriations bill that will be approved in the next week or so.

Two easings that could’ve passed in 2009 must wait because of the delay: Portable estate tax exemptions. Under current law, if a spouse passes away without having fully used up his or her exemption, the balance is wasted. Taxwriters want to ensure that any unused exemption goes to the surviving spouse. That way, taxpayers needn’t set up complicated trusts in their wills solely to save estate taxes.

And reintegrating the gift and estate taxes. The lifetime gift tax exemption is $1 million, less than a third of the estate tax exemption. Combining the two again would let taxpayers make larger lifetime gifts tax free to their heirs. Both changes must wait till 2010, when Congress will have more time on its calendar for debate.

Let us know if you have questions or comments. Thanks,

Steven