December Tips
Year-End Planning
Many tax maneuvers must be done before year-end. Here is a last minute list of items. If you have any questions please don't hesitate to contact us.
- Deferring Income
- Accelerating Deductions
- Residential Tax Credits
- Charitable Contributions
- Investment Gains-Losses
- Retirement Plan Contributions
- Roth Conversions
Articles in this Month's Issue
Tax Efficient Investing Strategy
What would you say if I told you that you can increase your long-term investment portfolio returns without increasing the risk or even changing which investments you use? You would probably call me crazy or a liar. The fact is, it is relatively easy to do. It has to do with being tax efficient and lowering the tax bill those investments generate.
Many people have investments in various accounts like 401(k), IRA, Roth, annuities, and brokerage accounts. Each of these account types have their own unique taxing structure. By matching up investments by tax efficiency, you can lower the tax bill which keeps more money invested to compound and grow.
Corporate Bonds vs. Growth Stock Mutual Fund
Let us look at a corporate bond. This particular bond earns an annual coupon of 7%. That 7% is taxed entirely at ordinary income tax rates. That rate is whatever the marginal tax rate at the time. For this example we will use someone in the highest current tax bracket (35%) but this is applicable to all tax brackets.
The growth stock mutual fund pays a relatively low dividend (which are mostly qualified) and occasionally sell stocks which have (hopefully) grown in value. When the sales of stock are recorded and the dividends are paid, the tax rate for most people will be 15%. So if the mutual fund has a long-term overall gain of 10%, 1% may come from dividends and the rest from capital gains. If the fund buys and sells about 30% of their stocks every year and most are long-term capital gains, then about 3% of the annual 10% long-term gain would be taxed annually.
So let us look at an example:
$10,000 investment in a corporate bond earns 7% or $700. The total tax bill would be $245 (35% x $700). After tax, the new value would be worth $10,455.
$10,000 investment in the growth stock mutual fund earns 10% or $1,000 for the year. $100 (1%) of the return is qualified dividends and $300 (3%) is long-term capital gains. At the 15% long-term capital gains and qualified dividend rate the total tax bill would be $60 ($400 x 15%). After tax, the new value would be $10,940.
This example illustrates the tax treatment in a brokerage account. If this person had both of these investments in an IRA, the growth stock mutual fund and bond would have no tax due and be worth $11,000 and $10,700 respectively. People often though have multiple account types. If they put the growth stock mutual fund in their brokerage and the bond in their IRA the total tax bill would be $60 because the tax inefficient bonds would not be taxed currently and the tax efficient growth stock would have minimal current taxation. By splitting the investments between a brokerage and IRA, the combined value would be $21,640 vs. $21,395 if it was all brokerage. No difference in investments, just lower taxes.
Another tax issue to consider is when the growth stock mutual fund is sold, it could have lots of long-term capital gains built into it. At that point the tax would be at 15%, if the gain was in the IRA, it would be taxed at ordinary income tax rates when it comes out to be spent. So it is possible to get better long-term tax treatment for growth assets outside a traditional IRA structure than in it. This is not always the case because tax is only paid on distribution from the IRA, if it stays in long enough, the compound interest can outweigh the benefits of long-term capital gains treatment.
The bottom line is that understanding the tax characteristics of your investments and matching those up efficiently with your available investment accounts can mean real tangible tax savings. Long-term if you can add .25% - .50% in additional return without adding risk by executing this strategy. Over many years the savings add up.
Posted by Ben Gurwitz on 8th December, 2011 | Comments | Trackbacks | Permalink
Tags: Investments, Dec 11, Retirement Accounts, Tax Planning
Near-Retirees Overestimating Withdrawal Needs
As retirees shift their focus from accumulating assets to creating an ongoing stream of income, many are not prepared to start planning from a new vantage point. This lack of perspective may explain why, according to a recent survey, many retirees anticipate making annual withdrawals that are too large, and run the risk of outliving their assets.
How Much to Withdraw
Historically, financial advisors have recommended that retirees limit annual withdrawals to a maximum of 3% to 5% of assets, adjusted for inflation, to limit the chances of running out of money. Yet a recent survey indicated the following: 1
- Nearly one-third of respondents believed they could withdraw between 7% and 10% annually.
- Just over 10% anticipated that they could withdraw between 11% and 15%.
Many respondents also underestimated the percentage of their preretirement income they would need annually to pay for living expenses. Only 45% of respondents understood that retirees typically need between 80% and 90% of preretirement income to maintain their preretirement standard of living.
Factors Affecting Retirement Income
If your retirement assets are running short, a variety of factors are likely to influence how much you will need during your later years:
- Your retirement age. Collecting Social Security at your earliest opportunity, which for most people is age 62, results in a permanent reduction of between 20% and 30% in the amount of your monthly benefit.
- Medical expenses. It's no secret that Medicare is experiencing financial stress and employer-sponsored health care plans for retirees are less generous than they formerly were. The Employee Benefit Research Institute has estimated that a couple retiring at age 65 with median drug expenses would need to accumulate $271,000 to ensure a 90% probability that they will have enough to pay for medical care. This amount does not include the cost of long-term care, which would make the estimate even higher.
- Housing. A large mortgage or other indebtedness limits financial flexibility. If you live in spacious quarters, consider how you will be able to finance mortgage payments, taxes, maintenance, utilities, condo fees, and other expenses.
- Discretionary costs of living. It can be difficult to control expenses for necessities such as utilities and health care. But variable costs, such as restaurant meals and vacations, are a different matter. Review how you may be able to trim variable costs before you retire without leading a Spartan lifestyle. Getting used to a more efficient mode of living may help you in your transition to retirement.
Source/Disclaimer:
1 Source: MetLife, Met Life Mature Market Survey, October 2011.
November 2011 — This column is provided through the Financial Planning Association, the membership organization for the financial planning community, and is brought to you by Jim Oliver, a local member of FPA.
Required Attribution
Because of the possibility of human or mechanical error by McGraw-Hill Financial Communications or its sources, neither McGraw-Hill Financial Communications nor its sources guarantees the accuracy, adequacy, completeness or availability of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information. In no event shall McGraw-Hill Financial Communications be liable for any indirect, special or consequential damages in connection with subscriber's or others' use of the content.
© 2011 McGraw-Hill Financial Communications. All rights reserved.
Tax Changes for 2011
Whether you file as an individual, a corporation, a small business owner, or are self-employed, as the end of the year draws near, you're probably thinking ahead to tax season and filing your taxes.
Most tax provisions of course, remain the same (IRA contribution limits for example), but a few such as personal exemptions have been adjusted for inflation and others have been extended due to legislation and are set to expire at the end of 2012.
From tax credits, exemptions and deductions for individuals and Section 179 expensing for small businesses, here's what you need to know about tax changes for 2011. .
Individuals
From personal deductions to tax credits and educational expenses, many of the tax changes relating to individuals remain in effect through 2012 and are the result of tax provisions that were either modified or extended by the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 that became law on December 17, 2010.
Personal Exemptions
The personal and dependent exemption for tax year 2011 is $3,700, up $50 from 2010.
Standard Deductions
In 2011 the standard deduction for married couples filing a joint return is $11,600, up $200 from 2010 and for singles and married individuals filing separately it's $5,800, up $100. For heads of household the deduction is $8,500, also up $100 from 2010.
The additional standard deduction for blind people and senior citizens is $1,150 for married individuals, up $50, and $1,450 for singles and heads of household, also up $50.
Income Tax Rates
Due to inflation, tax-bracket thresholds will increase for every filing status. For example, the taxable-income threshold separating the 15-percent bracket from the 25-percent bracket is $69,000 for a married couple filing a joint return, up from $68,000 in 2010.
Estate and Gift Taxes
The recent overhaul of estate and gift taxes means that there is an exemption of $5 million per individual for estate, gift and generation-skipping taxes, with a top rate of 35%. For married couples the exemption is $10 million.
Alternative Minimum Tax (AMT)
AMT exemption amounts for 2011 are slightly higher than those in 2010 at $48,450 for single and head of household fliers, $74,450 for married people filing jointly and for qualifying widows or widowers, and $37,225 for married people filing separately.
Marriage Penalty Relief
For 2011, the basic standard deduction for a married couple filing jointly is $11,600, up $200 from 2010.
Pease and PEP (Personal Exemption Phaseout)
Pease (limitations on itemized deductions) and PEP (personal exemption phase-out) limitations do not apply for 2011, but these are set to expire at the end of 2012.
Flexible Spending Accounts (FSA)
The Affordable Care Act, enacted in March, established a new uniform standard, effective January 1, 2011, that applies to FSAs and health reimbursement arrangements (HRAs).
Under the new standard, the cost of an over-the-counter medicine or drug cannot be reimbursed from the account unless a prescription is obtained. The change does not affect insulin, even if purchased without a prescription, or other health care expenses such as medical devices, eye glasses, contact lenses, co-pays and deductibles.
The new standard applies only to purchases made on or after Jan. 1, 2011, so claims for medicines or drugs purchased without a prescription in 2010 can still be reimbursed in 2011, if allowed by the employer's plan.
A similar rule went into effect on Jan. 1, 2011 for Health Savings Accounts (HSAs), and Archer Medical Savings Accounts (Archer MSAs).
Long Term Capital Gains
In 2011, long-term gains for assets held at least one year are taxed at a flat rate of 15% for taxpayers above the 25% tax bracket. For taxpayers in lower tax brackets, the long-term capital gains rate is 0%.
Individuals - Tax Credits
Adoption Credit
A refundable credit of up to $13,360 for 2011 is available for qualified adoption expenses for each eligible child.
Child and Dependent Care Credit
If you pay someone to take care of your dependent (defined as being under the age of 13 at the end of the tax year or incapable of self-care) in order to work or look for work, you may qualify for a credit of up to $1,050 or 35 percent of $3,000 of eligible expenses.
For two or more qualifying dependents, you can claim up to 35 percent of $6,000 (or $2,100) of eligible expenses. For higher income earners the credit percentage is reduced, but not below 20 percent, regardless of the amount of adjusted gross income.
Child Tax Credit
The $1,000 child tax credit has been extended through 2012. A portion of the credit may be refundable, which means that you can claim the amount you are owed, even if you have no tax liability for the year. The credit is phased out for those with higher incomes.
Energy Tax Credits for Homeowners
Energy tax credits for homeowners expire at the end of 2011 and are not as generous as in previous years. In addition, a taxpayer who has claimed an amount of $500 in any previous year is not eligible for this tax credit.
Homeowners can claim an Energy Star window tax credit of up to $200 maximum as well as a water heater tax credit, which includes electric, natural gas, propane, or oil, up to a maximum of $300. The same maximum ($300) applies to air conditioners, but insulation, doors, and roof credits are capped at $500. The furnace tax credit (includes natural gas, propane, oil, or hot water) and is capped at $150 maximum and efficiency must be at 95%.
Earned Income Tax Credit (EITC)
The maximum EITC for low and moderate income workers and working families is $5,751, up from $5,666 in 2010. The maximum income limit for the EITC has increased to $49,078, up from $48,362 in 2010. The credit varies by family size, filing status and other factors, with the maximum credit going to joint filers with three or more qualifying children.
Individuals - Education Expenses
Coverdell Education Savings Account
For two more years, you can contribute up to $2,000 a year to Coverdell savings accounts. These accounts can be used to offset the cost of elementary and secondary education, as well as post-secondary education.
American Opportunity Tax Credit (Higher Education)
The expansion of the Hope Scholarship Credit by the American Opportunity Tax Credit has been extended through 2012. For 2011, the maximum Hope Scholarship Credit that can be used to offset certain higher education expenses is $2,500, although it is phased out beginning at $160,000 adjusted gross income for joint filers and $80,000 for other filers.
Employer Provided Educational Assistance
Through 2012, you, as an employee, can exclude up to $5,250 of qualifying post-secondary and graduate education expenses that are reimbursed by your employer.
Lifetime Learning Credit
A credit of up to $2,000 is available for an unlimited number of years for certain costs of post-secondary or graduate courses or courses to acquire or improve your job skills. For 2011, the credit is fully phased out at $122,000 adjusted gross income for joint filers and $61,000 for others.
Student Loan Interest
For 2011 and 2012, the $2,500 maximum student loan interest deduction for interest paid on student loans is not limited to interest paid during the first 60 months of repayment. The deduction begins to phase out for higher-income taxpayers.
Tuition and Related Expenses Deduction
For 2010 and 2011, there is an above-the-line deduction of up to $4,000 for qualified tuition expenses. This means that qualified tuition payments can directly reduce the amount of taxable income, and you don't have to itemize to claim this deduction. However, this option can't be used with other education tax breaks, such as the American Opportunity Tax Credit, and the amount available is phased out for higher-income taxpayers.
Individuals - Retirement
Roth IRA Conversions
There is no longer an income limit for taxpayers who want to convert regular IRAs into Roth IRAs. The difference is that taxpayers who convert to Roth IRAs in tax year 2011 must pay taxes on the conversion income now instead of deferring it in later years as was the case in 2010.
Businesses
Standard Mileage Rates
The standard mileage rate increases to 51 cents per business mile driven (19 cents per mile driven for medical or moving purposes and 14 cents per mile driven in service of charitable organizations) for the first half of 2011. From July 1, 2011 to December 31, 2011 however, the rate increases to 55.5 cents per business mile. This increase is a special adjustment by the IRS and reflects higher gasoline prices.
Health Care Tax Credit for Small Businesses
Small business employers who pay at least half the premiums for single health insurance coverage for their employees may be eligible for the Small Business Health Care Tax Credit as long as they employ fewer than the equivalent of 25 full-time workers and average annual wages do not exceed $50,000. The credit can be claimed in tax years 2010 through 2013 and for any two years after that. The maximum credit that can be claimed is an amount equal to 35% of premiums paid by eligible small businesses.
Section 179 Expensing
In 2011 (as well as 2010), the maximum Section 179 expense deduction for equipment purchases is $500,000 ($535,000 for qualified enterprise zone property) of the first $2 million of certain business property placed in service during the year. The bonus depreciation increases to 100% for qualified property. If the cost of all section 179 property placed in service by the taxpayer during the tax year exceeds $2 million, the $500,000 amount is reduced, but not below zero. Please contact us if you need help understanding which deductions and tax credits you are entitled to. We are always available to assist you.
Improving Your Credit Score
Your credit score is a number that lenders use to gauge how likely you are to repay debts on time. It is derived from information compiled in a credit report, including your payment history (whether you have missed or been late with any payments for bills or loans), the amount you owe creditors compared with the amount of credit that is available to you, and the extent of your credit history (how long various accounts have been open).
Know Your Number
Before launching a campaign to raise your credit score, know what you are shooting for. Get a current copy of your credit report and review it for accuracy. All U.S. consumers are entitled to free annual credit reports from the major credit reporting agencies, which are Experian, Equifax, and TransUnion. You can request all three reports at www.AnnualCreditReport.com. Unlike credit reports, your credit score is not free. You can purchase your score from one of the above-mentioned agencies or from www.myFICO.com. A typical credit score will range between 300 and 850 points. Although all lenders make decisions based on the particulars of the lending situation, generally speaking, the higher your score, the lower the perceived risk to the lender, and the more attractive the interest rate you will be offered.
Room for Improvement
A few tips for raising or maintaining a higher credit score include:
• Paying your accounts on time and keeping your balances low. Lenders are looking for a proven track record of making timely payments. Payment history determines about 35% of your credit score.
• Being conservative in the amount of available credit you use at any given time. About 30% of your score is determined by what the industry refers to as your "utilization ratio," which is the amount you owe in relation to the amount of credit available to you. If that percentage is more than 50%, your score will be lower.
• Holding on to older, unused accounts. The longer an account has been open and managed successfully, the higher your score will be.
• Maintaining a diversified credit mix. If you hold an auto loan, a home mortgage, and credit cards that are well managed, you will generally have a higher credit score than someone whose credit consists mainly of finance companies.
November 2011 — This column is provided through the Financial Planning Association, the membership organization for the financial planning community, and is brought to you by Jim Oliver, a local member of FPA.
Required Attribution Because of the possibility of human or mechanical error by McGraw-Hill Financial Communications or its sources, neither McGraw-Hill Financial Communications nor its sources guarantees the accuracy, adequacy, completeness or availability of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information. In no event shall McGraw-Hill Financial Communications be liable for any indirect, special or consequential damages in connection with subscriber's or others' use of the content.
© 2011 McGraw-Hill Financial Communications. All rights reserved.
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