Tag Archives: life insurance

2012 year-end tax planning – 2012 vs. 2013 tax strategies requiring action now

Posted on by

The goal for tax planning, as always, is to minimize the total that you pay for 2012 and 2013. However, this year is tricky. Here is why:
First, if your 2013 income is expected to be over $250,000 ($200,000 for singles), you cannot just accelerate write-offs from 2013 into 2012 and defer income to 2013 because your taxes will be higher in 2013. There is a new 3.8% tax that works like this, for example: recognizing a capital gain in 2012 avoids that tax in 2013 and also reduces your 2013 adjusted gross income, which may keep it below the threshold for imposing that tax next year. (See below for more details on the new tax.)
Second, regardless of who becomes President, Congress is likely to reduce the amount or value of itemized deductions. Thus, you may want to accelerate what you can into 2012.
Third, as always, combine your tax planning with your investment strategies, such as tax loss harvesting and rebalancing (see explanations at the end).
Last, there are other issues to review for 2012, including converting your Roth IRA; gifting to children and grandchildren for estate planning purposes (to use the $5 million unified credit); and funding college for children or grandchildren.
However, if you will owe the alternative minimum tax (AMT), you may have to revise your strategy. Many write-offs must be added back when you calculate the AMT liability, including sales taxes, state income taxes, property taxes, some medical and most miscellaneous deductions. Large gains can also trigger the tax if they cost you some of your AMT exemption.
The best tool for planning is to do a projection for both 2012 and 2013, then see what items you can affect to reduce the total tax for both years.
Assuming you will not have an AMT problem in either year, then in 2012 you could:
• Take a bonus this year to save the 0.9% for a high-income earner;
• Sell investment assets to save the 3.8% tax next year so the gain or income is in 2012 (e.g., sales of appreciated property or business interests, Roth IRA conversions, potential acceleration of bonuses or wages);
• Defer some itemized deductions to 2013 (but, be wary of the possibility that these will be capped in 2013 and can affect your AMT for either year);
• Accelerate income from your business or partnership, depending on whether it is an active or passive business; and
• Convert Roth IRAs in 2012 as noted above.
Then in 2013 and future years, you could:
• Purchase tax-exempt bonds;
• Review your asset allocation to see if you can increase your exposure to growth assets, or add to tax-exempt investments, rather than income producing assets. Also, place equities with high dividends and taxable bonds with high interest rates into retirement accounts;
• Bunch discretionary income into the same year whenever possible so that some years the MAGI stays under the threshold;
• While we do not recommend tax-deferred annuities, they can help save tax now to pay taxes in the future when the payments are withdrawn. (These are not recommended due to high fees, illiquidity and often poor performance);
• Add real estate investments where the income is sheltered by depreciation;
• Convert IRA assets to a Roth. Even though the future distributions from both traditional and Roth IRAs are not treated as net investment income, the Roth will not increase the threshold income; and
• Reduce AGI by “above-the-line” deductions, such as deductible contributions to IRAs and qualified plans, and health savings accounts and the possible return of the teach supplies deduction.
Note, however, Congress has not finalized the 2012 rules. Some expected steps are:
• An increase in the AMT exemption to $78,750 ($50,600 for singles), raising it from 2012 rather than dropping back to 2001 rates;
• Teacher $250 supplies deduction on page 1 of 1040, as mentioned above; and
• IRA $100,000 tax free gifts to charities.
Here are the details on the 2013 tax increases, enacted to help fund health care:
• A new 3.8% Medicare tax on the “net investment income,” including dividends, interest, and capital gains, of individuals with income above the thresholds ($250,000 if married and $200,000 if single);
• 0.9% increase (from 1.45% to 2.35%) in the employee portion of the Hospital Insurance Tax on wages above the same thresholds;
• Increase in the top two ordinary income tax rates (33% to 36% and 35% to 39.6%);
• Increase in the capital gains rate (15% to 20%);
• Increase in the tax rate on qualified dividends (15% to a top marginal rate of 39.6%).
• Reinstatement of personal exemption phase-outs and limits on itemized deductions for high-income taxpayers (effectively increasing tax rates by 1.2%).
• Reinstatement of higher federal estate and gift tax rates and lower exemption amounts.
If these changes take effect, the maximum individual tax rates in 2013 could be as high as follows:
2012 vs. 2013
Wages: 36.45 vs. 43.15%
Capital gains: 15 vs. 20%
Qualified dividends: 15 vs. 46.6%
Other passive income: 35 vs. 46.6%
Estate taxes: 35 vs. 55%
*Includes 1.45% employee portion of existing Hospital Insurance Tax.
**Estate and gift tax exemption also drops from $5.12 million to $1 million, if Congress does not act soon.
Explanations:
Tax-loss harvesting:
>Review your investments to find stocks, mutual funds or bonds that have gone down so that selling now will create a loss. This loss shelters realized gains and up to $3,000 of other income.
N.B. – If you replace the stock, mutual fund or bond, wait 30 days or use similar, but not identical, item. Otherwise, the “wash sale” rules eliminate realization of the loss.
Rebalancing:
>review your asset allocation to see if any portion is over or under-weighted. Then sell and buy to bring the allocation back in line. However, if you sell and re-buy now, before a dividend is declared, you will receive a 1099 for a taxable dividend in the new fund for investment returns in which you did not participate.

Thanks to the Kiplinger’s Tax Newsletter, Sapers & Wallack and others for ideas and information.

Whole Life is not a great “Investment Alternative” – use the death benefit when age becomes a factor

Posted on by

Whole Life is a poor “investment alternative.” Consider what an insurance company may say, annotated with our comments:

1) Tax Deferred
Does not make up for fees and poorer returns. The mortality fees alone can bring the total fees up over 2%, which compares poorly to a stock index bought via an ETF, were the fees are below .1%
2) Attractive returns compared to bank alternatives
Yes, to a bank, but NOT to your own portfolio of stocks or funds
3) More than initial deposit guaranteed in early years
Only at first and at some cost
4) Strong dividend history
Dividends are only a part of the return on investments – whole life is far worse than a good variable life policy let alone stocks purchased directly or via mutual funds, over time
5) Death benefit (DB) income tax free
Always true of life insurance because it is subject to estate taxes
6) Returns very high if DB paid in early years
“so what?” This is intended to be a long-term purchase
7) Beneficiary can be changed easily without having to redo wills and trusts
Meaning that proper estate planning is not being done
8) Annuitization of other assets easier to do, which can lead to higher retirement income
“Easier” means you pay them to do it instead of doing it yourself, which means shifting the allocation of your own portfolio depending on cash needs

Update on estate planning – what should you gift now?

Posted on by

Estate planning remains stuck in limbo. That is, after 2012, the $5 million credit for gift and estate taxes goes away and we could be back at a $1 million credit. Also, the generation skipping tax limit now at $5 million would decrease. Finally, the portability of estate tax exemptions between spouses expires, meaning that the survivor can no longer use any credit amount not used by the first spouse, which would allow more to pass on estate tax free.
So far, Congress has taken no action. Many expect the 35% rate and a credit of at least $3 million to be the law for 2013 on. However, Congress failed to fix the estate tax for 2010 so nothing is certain.

Planning: This means you need to review your estate plan, especially your gifting strategies, and act now to take advantage of the higher gift tax credit. You can gift up to $5 million of assets free of gift tax now, or $10 million for married couples. The benefit is that all future income and appreciation on these gifts is removed from your estate. The downside is that the gifts are irrevocable, so you must be certain that what you pass on now you will not need later.
You always want to select assets that you expect will grow in value. If the assets decline, the strategy is frustrated. An example of what could go wrong is gift of a home at peak values that is now worth far less.

Remember that you have the annual gift tax exclusion allowing you and your spouse can each give $13,000 per year to any individual without eating away at your gift and estate tax credit. And note: any payments made to colleges or hospitals for the benefit of another person are not counted at all. (No gift tax return is required for these excluded amounts.)

How do you effectively structure the gift? Here are some examples:
• Family limited liability company (FLLC): With real estate or business assets, you can transfer minority interests in the FLLC to children or grandchildren. You retain control and the amount you gift is discounted because the minority interests lack control and lack marketability. You will need an appraisal for the value and the discount.
• Dynasty trust: This type of trust is designed to pass assets on multiple generations. Distributions can be made to the first generations, but they never actually receive a final amount – they rely on the trustee for any amounts to be distributed to them.
• Grantor retained annuity trust (GRAT): This trust transfers assets to children after a specified term while retaining a fixed annuity. The amount you gift is discounted, because children do not receive it until the end of the term. If the amount transfers, you succeed in transferring a discounted amount that becomes worth much more to the next generation.
• Qualified Personal Residence Trust (QPRT) Like the GRAT, your children receive your house in the future, so the value of the gift made now is discounted. You can even stay in the house after that term, but you have to pay rent, which is in effect another gift.

One note of caution: some have expressed the concern that if Congress does not act, the IRS could try to take back the excess in some fashion. Be sure to consult with your estate tax advisor before taking any moves.
We added gifting as a “to do” on the Finance Health Day page .

Tax planning and 2011 estate tax law

Posted on by

While we await more details, recent action by Congress has the Bush tax cuts continuing for two more years, making the 2010 to 2011 tax planning straight forward – much like past years.

The new law provides relief on the AMT, no reduction in deductions and other benefits, which we plan to review in greater detail.

Also, it appears that, rather than return to a $1 million unified credit for estate taxes, at least a $3.5 million, if not a $5 million, credit and perhaps as low as a 35% tax rate will be the law next year.

Until we have more, please consider this summary of Tax planning: 2010 tips and traps, and 2011 changes

For 2010, some old provisions return and some new changes require action now:

2010 conversion to a Roth IRA has no income limit and two years to pay the taxes (please see to convert or not to convert).

Certain advantages in 2009 are lost for 2010 (see tax planning 2009 tips and traps and 2010 changes):
• AMT patch falls back;
• Casualty and theft loss limits fall back;
• Educator and tuition and fees deductions against adjusted gross income are not available;
• Deduction of state and local sales taxes ends;
• Exclusion of $2,400 of unemployment income ends; and
• Exclusion of income from qualified distributions from IRAs to charities ends.

However, some still apply in 2010:
• New home buyer credit (through the extended date)
• Energy Credit for solar power, fuel cells and certain energy efficient improvements are Schedule A deductions. There are two types of credit depending on what improvements were made to your home and taking the deductions requires you to have documentation.
• A tax refund can be used to buy U.S. Series I bonds.
• Note that a dependent child’s income is taxed when it exceeds $1,900.
• Educator’s Expense

Note that not all states accept the IRS changes, so the information and outcome could be different.

As we said before, tax planning involves a multi-year view to optimize what you end up paying.

You should also review your mortgage when you review tax information.

Estate planning – your homework before and after

Posted on by

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