If Congress does not act soon, January 1st, 2011 will see one of the largest increases in taxation ever. There are no fewer than 10 adjustments to the tax code that affect 3 different areas of financial planning, and probably require all of us to revisit some of the assumptions in our longer term wealth management. Here is a quick review of things to come:
Income Tax Rate Increases
1. Top Federal Rate rises from 35% to 39.6%
2. 33% Federal Rate rises to 36%
3. 28% Federal Rate rises to 31%
4. 25% Federal Rate rises to 28%
5. 10% expires and reverts to 15%
6. Standard deduction for married couples no longer double that of unmarried filers
True, over half of these 10 changes come from Federal Income Tax increases, but the significance of rising income tax for all of us is huge given the fragile state of the economic recovery. There is an obvious affect on expendable income, as well as small business’ ability to grow. At the same time, there is a need to balance that want for economic growth with growing government debt.
Taxes on Investment
7. Maximum Long-Term Capital Gains tax rises from 15% to 20%
8. Tax rate for qualified dividends rises from 15% to Ordinary Income rates (as high as 39.6%)
It is important to note that an increase in long-term capital gains from 15 to 20% is not a 5% increase… it is a 33% increase! These two potential changes will be very significant to our thoughts on after-tax investments. What I call Asset Location (meaning the choice of investment vehicle & use of registration) will become even more important, as tax efficiency and transparency of holdings becomes paramount. It may become tempting for investors to run to federally tax-free muni bonds, but more than likely these will not be the best option. Tax-free investments tend to benefit investors in the highest tax brackets the most.
Estate Taxes
9. Estate tax redemption will decrease from $3.5 million (2009) to $1 million
10. Top Estate and Gift tax rates rise from 45% (2009) to 55%
Estate planning has been a moving target since the “sun-set” provision was written into legislation earlier in the decade. 2010 saw most wealth transfers pass untaxed. With these two changes poised to set estate planning assumptions back 10 years, now is a good time to review your documents to make sure they still accomplish the goals for which they were originally designed.
Because of these significant changes, the team at our office is hosting a workshop and open house on this topic in October to kick off our tax planning season. Please be sure to attend!
Wednesday, September 15, 2010
Monday, August 9, 2010
Thoughts on Fixing Social Security
"We need to look at the American people and explain to them that we're broke," Boehner (US Senator, John Boehner) was quoted as saying recently in The Pittsburgh Tribune-Review. "If you have substantial non-Social Security income while you're retired, why are we paying you at a time when we're broke? We just need to be honest with people."
I think that quote is about as clear an indication as we will get from a politician about Social Security. The system is quickly charging toward insolvency unless significant changes are made. A stark fact that has almost gone unnoticed by the general public is that social security (tax) revenues fell below benefit costs this year with the economic crisis, as more people retired early and fewer workers were paying in benefits. Something needs to be done quickly.
Here are some of the thoughts that have been proposed, and my two cents on each:
Increase the normal retirement Age to 70--This one is sort of a no-brainer. It has been the typical response so far out of Washington. Clearly, as life expectancy increases and the ratio of workers to SS beneficiaries decreases, the age to claim retirement benefits will need to increase.
Increase Early Retirement Age--People can and do claim a reduced retirement benefit at age 62. If there is a need to raise the normal retirement age, then clearly there is a need to raise the age to claim early retirement benefits. Given that current projections are for SSA to exhaust payouts by 2041, this seems a likely change in tandem to the increase in the normal retirement age.
Tie Cost-of-Living Increases to Wages--Consumer price index is a traditional measure of inflation (tracking the price fluctuations of a basket of non-durable consumer goods). Actual wages have grown at a much slower rate over time, and this could effectively slow down the amount of benefits paid out of the trust.
Working Longer-–Currently, full Social Security benefits are attained through working 40 quarters; with a quarter being defined as $1,120 of earnings. I could conceivably see two potential ways to change this: one in increasing the number of quarters, or two in changing the dollar amount that qualifies for a quarter.
Raising the taxable wage base--$106,800; that’s where current taxes for social security revenue purposes stop. Meaning anyone who earns a dollar over that amount, that dollar is not taxed for social security purposes. This seems like another no-brainer, given the dire state that the Social Security trust is in.
I am unsure what it will take to make a significant step toward fixing the system. More than likely it will take a bold move by Congress, and mix and match of these and other suggested changes. With an impending insolvency and an economy that is not forecasted to grow at break-neck speed, clearly something must be done.
I think that quote is about as clear an indication as we will get from a politician about Social Security. The system is quickly charging toward insolvency unless significant changes are made. A stark fact that has almost gone unnoticed by the general public is that social security (tax) revenues fell below benefit costs this year with the economic crisis, as more people retired early and fewer workers were paying in benefits. Something needs to be done quickly.
Here are some of the thoughts that have been proposed, and my two cents on each:
Increase the normal retirement Age to 70--This one is sort of a no-brainer. It has been the typical response so far out of Washington. Clearly, as life expectancy increases and the ratio of workers to SS beneficiaries decreases, the age to claim retirement benefits will need to increase.
Increase Early Retirement Age--People can and do claim a reduced retirement benefit at age 62. If there is a need to raise the normal retirement age, then clearly there is a need to raise the age to claim early retirement benefits. Given that current projections are for SSA to exhaust payouts by 2041, this seems a likely change in tandem to the increase in the normal retirement age.
Tie Cost-of-Living Increases to Wages--Consumer price index is a traditional measure of inflation (tracking the price fluctuations of a basket of non-durable consumer goods). Actual wages have grown at a much slower rate over time, and this could effectively slow down the amount of benefits paid out of the trust.
Working Longer-–Currently, full Social Security benefits are attained through working 40 quarters; with a quarter being defined as $1,120 of earnings. I could conceivably see two potential ways to change this: one in increasing the number of quarters, or two in changing the dollar amount that qualifies for a quarter.
Raising the taxable wage base--$106,800; that’s where current taxes for social security revenue purposes stop. Meaning anyone who earns a dollar over that amount, that dollar is not taxed for social security purposes. This seems like another no-brainer, given the dire state that the Social Security trust is in.
I am unsure what it will take to make a significant step toward fixing the system. More than likely it will take a bold move by Congress, and mix and match of these and other suggested changes. With an impending insolvency and an economy that is not forecasted to grow at break-neck speed, clearly something must be done.
Monday, June 21, 2010
24 Hour News Television & the Creation of Crisis
Mini-corrections are normal for investment markets. It can be difficult to remember that coming out of this recent financial crisis and recession, but after prolonged bull-market periods it is quite normal to see a bit of a pull-back. Since 1927, the average correction within a bull market has been a decline of 13.3%, which we are still short of. It is normal for our relationship with risk and fear to be skewed after the systemic collapse in 2008, but the “creation of crisis” found on the television airwaves does not help our behavioral relationship with our finances.
Fox Business continues to ask on a daily basis “Is the World Broke?” “BREAKING NEWS” flashes across the screen on CNBC the moment an executive takes a labored breath at a domestic large-cap firm. Isn’t every news piece they are running “breaking news”? The question is whether the delivery needs to be in such a way as to disturb an internal crisis in the viewer.
Additionally, nearly every other commercial on business news stations is for investments in gold bars—a traditional crisis inflationary hedge instrument. While a tilt to commodity holdings for some investors may be appropriate as a good hedge against inflation, it is unconscionable to solicit the viewer to move all of their money to gold bars or coins because we are in a prolonged recession. At this point, that could be the equivalent of buying Yahoo stock at the height of the NASDAQ in 2000.
The point of my anecdote is not imply that we are some how out of the woods from a prolonged global recession, but merely to reflect that the next crisis is not occurring every minute. Behavioral finance, or balancing fear and greed with a long-term investment strategy, is something each of us struggle with, and 24-hour news television sometimes only adds one more irrational voice in our heads.
Fox Business continues to ask on a daily basis “Is the World Broke?” “BREAKING NEWS” flashes across the screen on CNBC the moment an executive takes a labored breath at a domestic large-cap firm. Isn’t every news piece they are running “breaking news”? The question is whether the delivery needs to be in such a way as to disturb an internal crisis in the viewer.
Additionally, nearly every other commercial on business news stations is for investments in gold bars—a traditional crisis inflationary hedge instrument. While a tilt to commodity holdings for some investors may be appropriate as a good hedge against inflation, it is unconscionable to solicit the viewer to move all of their money to gold bars or coins because we are in a prolonged recession. At this point, that could be the equivalent of buying Yahoo stock at the height of the NASDAQ in 2000.
The point of my anecdote is not imply that we are some how out of the woods from a prolonged global recession, but merely to reflect that the next crisis is not occurring every minute. Behavioral finance, or balancing fear and greed with a long-term investment strategy, is something each of us struggle with, and 24-hour news television sometimes only adds one more irrational voice in our heads.
Tuesday, May 11, 2010
The Return of Volatility
A confluence of events in Europe last week sent the broad market stock indicies crashing 1000 points intra-day. The Dow Jones Industrial Average fell below the 11,000 mark, and the bears decided to make a little run into this 12-month bull market.
Setting aside any potential human error on the trading side, we know that the markers generally hate uncertainty; and things had been fairly uncertain with regard to how the European Central Bank would respond to the debt crisis in Greece. Things came to a head last week, during the same time the UK elections left a hung parliament (no political party with a clear majority) for the first time since the 1970’s. Uncertainty times two for a very important political and economic region.
As the European Central Bank’s rescue package became clear by Monday morning, markets began to recover. When a coalition UK government (the conservative Tories and Liberal Democrats formed a cooperative majority in parliament) was announced, UK markets reacted dramtically; and all of a sudden the Dow is flirting with the upper 10,000’s again.
With more European debt issues likely in the future and a mid-term election later in the year in the US, you can imagine more market volatility is in the offing. Right now the economic domestic data still looks good:
• April was the 4th month in a row of positive employment growth, adding 300,000 new jobs, which was well above estimates.1
• Strong factory orders for March announced this week affirm the strength in the manufacturing sector. Excluding the volatile transportation component, orders recorded the strongest month in 5 years.2
• Becoming the standard of recent quarters, companies are beating Wall Street earnings estimates. Earnings improvements are beyond the benefits of cost cutting as 75% of companies within the S&P 500 have reported higher top-line sales from a year ago.3
• In response to the good earning reports and economic indicators, future earning estimates continue to enjoy upward revisions for all of 2010 and 2011. 4
Last week’s events continue to remind us of the interdependencies of world economies.
1 Bloomberg, May 7, 2010
2 Bloomberg, May 4, 2010
3 Zacks Investment Research, May 4, 2010
4 Standard & Poors, operating earnings estimates, May 4, 2010
Setting aside any potential human error on the trading side, we know that the markers generally hate uncertainty; and things had been fairly uncertain with regard to how the European Central Bank would respond to the debt crisis in Greece. Things came to a head last week, during the same time the UK elections left a hung parliament (no political party with a clear majority) for the first time since the 1970’s. Uncertainty times two for a very important political and economic region.
As the European Central Bank’s rescue package became clear by Monday morning, markets began to recover. When a coalition UK government (the conservative Tories and Liberal Democrats formed a cooperative majority in parliament) was announced, UK markets reacted dramtically; and all of a sudden the Dow is flirting with the upper 10,000’s again.
With more European debt issues likely in the future and a mid-term election later in the year in the US, you can imagine more market volatility is in the offing. Right now the economic domestic data still looks good:
• April was the 4th month in a row of positive employment growth, adding 300,000 new jobs, which was well above estimates.1
• Strong factory orders for March announced this week affirm the strength in the manufacturing sector. Excluding the volatile transportation component, orders recorded the strongest month in 5 years.2
• Becoming the standard of recent quarters, companies are beating Wall Street earnings estimates. Earnings improvements are beyond the benefits of cost cutting as 75% of companies within the S&P 500 have reported higher top-line sales from a year ago.3
• In response to the good earning reports and economic indicators, future earning estimates continue to enjoy upward revisions for all of 2010 and 2011. 4
Last week’s events continue to remind us of the interdependencies of world economies.
1 Bloomberg, May 7, 2010
2 Bloomberg, May 4, 2010
3 Zacks Investment Research, May 4, 2010
4 Standard & Poors, operating earnings estimates, May 4, 2010
Monday, May 3, 2010
Diagnosing Fiscal Fitness
Trying to be your own financial advisor can sometimes feel like trying to perform surgery on yourself. But, you can certainly try to diagnose your own fiscal fitness. Here are a few items to keep in mind when looking at the health of your finances:
• Emergency Fund – Usually recommended to have 3 to 6 months of nondiscretionary expenses available in very liquid holdings.
• Debt Coverage – A good measure of mortgage debt is 28% of gross income
• Savings Rates – The largest part of retirement planning is the actual savings element. Typical healthy savings rates are in the neighborhood of 10-12%.
• Net-Worth Growth – Calculated by subtracting your liabilities from your overall assets, it also helps to look at how your net worth trends over a period of time. Is there growth in your net worth?
• Asset Location – While much is often spoken of asset allocation in controlling risk tolerance, asset location is more telling of controlling exposure to the opportunity of difference financial vehicles (e.g., cash-value life insurance vs. term, liquidity of one investment vs. another, or tax-efficiency of one investment vs. another, etc.)
While these are some great elements to examine with regard to your current financial condition, making the right adjustments is key. Because of the plethora of decisions to be made in your financial life, self-diagnosis will probably only take you so far.
• Emergency Fund – Usually recommended to have 3 to 6 months of nondiscretionary expenses available in very liquid holdings.
• Debt Coverage – A good measure of mortgage debt is 28% of gross income
• Savings Rates – The largest part of retirement planning is the actual savings element. Typical healthy savings rates are in the neighborhood of 10-12%.
• Net-Worth Growth – Calculated by subtracting your liabilities from your overall assets, it also helps to look at how your net worth trends over a period of time. Is there growth in your net worth?
• Asset Location – While much is often spoken of asset allocation in controlling risk tolerance, asset location is more telling of controlling exposure to the opportunity of difference financial vehicles (e.g., cash-value life insurance vs. term, liquidity of one investment vs. another, or tax-efficiency of one investment vs. another, etc.)
While these are some great elements to examine with regard to your current financial condition, making the right adjustments is key. Because of the plethora of decisions to be made in your financial life, self-diagnosis will probably only take you so far.
Monday, April 19, 2010
Tax Planning vs. Tax Preparation: Start your 2010 strategy now.
While I took a short hiatus from blogging during the height of tax season in our office, the Dow Jones Industrial average blasted through the 11,000 mark—a significant level given the enormous drop witnessed in the fall of 2008. Time will tell if this will be a trading support level throughout 2010.
Having just come through tax preparation season in our office, though, I thought it prudent to take a moment to discuss tax planning versus preparation. Generally, the tax preparers in our office begin a meeting by asking some basic questions about financial decisions made over the past year…Did you buy a house? Did you collect unemployment? Was there an addition to your family this year? Did you purchase a car this past year? These are all reactive questions—answers provided after the fact, with little opportunity to change the tax impact.
There is a difference between tax preparation and tax planning. Tax preparation is simply completing your return: committing certain events to history and recognizing their tax consequences. Tax planning, on the other hand, is proactive in nature: you identify tax savings opportunities and create a roadmap to maximize them.
There is little doubt that with government spending and budget deficits exceeding previous records, the tax rates are going to increase. For that reason, now is the time to break the cycle of taking a reactive approach to addressing your tax exposure. This often looks at ways of reducing your taxable income, claiming potential tax credits, or, in the case of small business owners, optimizing your tax status (i.e, creation of an entity for your business to be able to use more tax deductions).
To get the true benefit of tax planning, have a strategy session with your preparer and your financial advisor. Get both on the same strategy page.
Having just come through tax preparation season in our office, though, I thought it prudent to take a moment to discuss tax planning versus preparation. Generally, the tax preparers in our office begin a meeting by asking some basic questions about financial decisions made over the past year…Did you buy a house? Did you collect unemployment? Was there an addition to your family this year? Did you purchase a car this past year? These are all reactive questions—answers provided after the fact, with little opportunity to change the tax impact.
There is a difference between tax preparation and tax planning. Tax preparation is simply completing your return: committing certain events to history and recognizing their tax consequences. Tax planning, on the other hand, is proactive in nature: you identify tax savings opportunities and create a roadmap to maximize them.
There is little doubt that with government spending and budget deficits exceeding previous records, the tax rates are going to increase. For that reason, now is the time to break the cycle of taking a reactive approach to addressing your tax exposure. This often looks at ways of reducing your taxable income, claiming potential tax credits, or, in the case of small business owners, optimizing your tax status (i.e, creation of an entity for your business to be able to use more tax deductions).
To get the true benefit of tax planning, have a strategy session with your preparer and your financial advisor. Get both on the same strategy page.
Monday, March 1, 2010
The 11 Pitfalls, Concerns, & Opportunites for Roth Conversion in 2010
When TIPRA (Tax Increase Prevention & Reconciliation Act) passed in 2005, it seemed like the opportunity for Roth IRA conversion would be a good one for some people. No one could have predicted the “perfect storm” of opportunity for Roth Conversion in 2010 that has ensued. Given record lows for the top income brackets, the sizeable government deficit that has mounted, and the Financial Crisis’ effects on account values of deferred retirement savings accounts, Roth Conversion in 2010 may be the largest tax planning opportunity some of us will ever see. Careful analysis should be taken by everyone to weigh whether or not a conversion strategy is right for you.
Given all that, I have found 11 pitfalls and considerations Californians should know about before they begin any analysis. They are:
1. Waiting Period – There is a 5 year waiting period before growth can be accessed on any Roth Conversion. Full income tax is applied if growth is touched prior to the 5 year wait. There is an additional 10% penalty if you are under 59 ½ .
2. The “Do-Over” Rule – Recharacterization can be done if you convert an account to Roth and the value is worth less around the time you are filing your taxes. If the Roth has lost value since conversion, you can recharacterize back to traditional IRA, and then reconvert at the lower value…lowering the tax burden.
3. Paying the Tax on Conversion – Generally, people should have after-tax savings in a separate account to pay for the tax on conversion. Withdrawing from a traditional IRA to pay the tax will cause a penalty for individuals under 59 ½ , and is probably not the best option for those over 59 ½ .
4. Treatment of Non-deductible IRAs – If you have been contributing after-tax dollars to a traditional IRA, the after-tax portion of the account that is converted to Roth will not be taxed (because you have already paid tax on this money). Additionally, you cannot pick and choose which portions or Ira accounts you wish to convert. You have one IRA in the eyes of the government, no matter how many accounts you have, and therefore any after-tax contributions must be converted pro-rata to the sum total of all traditional IRAs.
5. Converting Company Plans 1 – If you have an old 401k (403b or 457) from a previous employer and want to convert it to Roth, be sure to roll it over to IRA first. If you convert directly from 401k to Roth, you will not have the opportunity to recharacterize if the stock market moves against you.
6. Converting Company Plans 2 – If you want to make better use of mixed/non-deductible IRAs, convert before rolling an old 401k (403b or 457) to a traditional IRA. This will allow you to convert a larger portion of the after-tax IRA contribution.
7. Utilizing Tax Losses – This could be a great time to use net operating loss carry-forwards, charitable contribution carry-forwards, non-refundable tax credits, and pass-through losses to mitigate the taxes of conversion. Work with your tax advisor to coordinate this.
8. Financial Aid Loss – When applying for college financial aid, retirement accounts are generally discounted, but income is not. Roth IRA conversion is considered income and is classified this way on all IRS tax forms.
9. Converting SIMPLE IRAs – There is a 2-year holding period requirement on initial contributions to SIMPLE IRAs. Conversion to Roth prior to the 2-year hold could trigger a 10% penalty. Be sure you time this correctly.
10. Split the State Tax not the Federal – If you have the after-tax dollars to pay the tax on conversion, and there is not a need to manage tax brackets for your conversion strategy, you may consider paying the Federal taxes now (which are scheduled to increase) and use the 2-year deferral split option for State taxes.
11. Trying to Coordinate your Tax Advisor & your Financial Advisor – In all seriousness, this is an opportunity which requires the coordination of your financial advisor and your tax advisor. Be sure to include both in a strategy session to work out whether a full, partial, or multi-year conversion plan may be right. They will be able to help you wade through these and other pitfalls.
This is not meant as a do-it-yourself guide. Roth Conversion is potentially a great opportunity, but should be evaluated on an individual basis, given all of the considerations involved.
The preceding should not be construed as tax advice. Be sure to consult your tax advisor before making any decisions.
Given all that, I have found 11 pitfalls and considerations Californians should know about before they begin any analysis. They are:
1. Waiting Period – There is a 5 year waiting period before growth can be accessed on any Roth Conversion. Full income tax is applied if growth is touched prior to the 5 year wait. There is an additional 10% penalty if you are under 59 ½ .
2. The “Do-Over” Rule – Recharacterization can be done if you convert an account to Roth and the value is worth less around the time you are filing your taxes. If the Roth has lost value since conversion, you can recharacterize back to traditional IRA, and then reconvert at the lower value…lowering the tax burden.
3. Paying the Tax on Conversion – Generally, people should have after-tax savings in a separate account to pay for the tax on conversion. Withdrawing from a traditional IRA to pay the tax will cause a penalty for individuals under 59 ½ , and is probably not the best option for those over 59 ½ .
4. Treatment of Non-deductible IRAs – If you have been contributing after-tax dollars to a traditional IRA, the after-tax portion of the account that is converted to Roth will not be taxed (because you have already paid tax on this money). Additionally, you cannot pick and choose which portions or Ira accounts you wish to convert. You have one IRA in the eyes of the government, no matter how many accounts you have, and therefore any after-tax contributions must be converted pro-rata to the sum total of all traditional IRAs.
5. Converting Company Plans 1 – If you have an old 401k (403b or 457) from a previous employer and want to convert it to Roth, be sure to roll it over to IRA first. If you convert directly from 401k to Roth, you will not have the opportunity to recharacterize if the stock market moves against you.
6. Converting Company Plans 2 – If you want to make better use of mixed/non-deductible IRAs, convert before rolling an old 401k (403b or 457) to a traditional IRA. This will allow you to convert a larger portion of the after-tax IRA contribution.
7. Utilizing Tax Losses – This could be a great time to use net operating loss carry-forwards, charitable contribution carry-forwards, non-refundable tax credits, and pass-through losses to mitigate the taxes of conversion. Work with your tax advisor to coordinate this.
8. Financial Aid Loss – When applying for college financial aid, retirement accounts are generally discounted, but income is not. Roth IRA conversion is considered income and is classified this way on all IRS tax forms.
9. Converting SIMPLE IRAs – There is a 2-year holding period requirement on initial contributions to SIMPLE IRAs. Conversion to Roth prior to the 2-year hold could trigger a 10% penalty. Be sure you time this correctly.
10. Split the State Tax not the Federal – If you have the after-tax dollars to pay the tax on conversion, and there is not a need to manage tax brackets for your conversion strategy, you may consider paying the Federal taxes now (which are scheduled to increase) and use the 2-year deferral split option for State taxes.
11. Trying to Coordinate your Tax Advisor & your Financial Advisor – In all seriousness, this is an opportunity which requires the coordination of your financial advisor and your tax advisor. Be sure to include both in a strategy session to work out whether a full, partial, or multi-year conversion plan may be right. They will be able to help you wade through these and other pitfalls.
This is not meant as a do-it-yourself guide. Roth Conversion is potentially a great opportunity, but should be evaluated on an individual basis, given all of the considerations involved.
The preceding should not be construed as tax advice. Be sure to consult your tax advisor before making any decisions.
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