January Tips
With a new year comes increased limits for retirement plans and some deductions. Here are some of the revised figures for 2012:
- 401(k), 403(b) deferral limits : $17,000 per year
- Estate Tax: $5,120,000 per person
- Social Security wage limit: $110,100 per year
- Mileage Reimbursement Rates
Business: $.55/mile
Medical: $.23/mile
Charitable: $.14/mile
Articles in this Month's Issue
Roth Conversion Strategies
In 1997, the U.S. Congress established a new type of retirement account named after Senator William Roth. Although this account did not provide an immediate tax deduction, it did offer a powerful and simple concept-- all growth, if kept until retirement age, would be TAX-FREE. For many years, higher income Americans were unable to participate in either annual Roth contributions or Roth conversions due to income limits of the account. In 2006, because of the Pension Protection Act (PPA), employers began to amend their 401(k) & 403(b) plans to include Roth contributions without income restrictions, and in 2010, the income limit was lifted for Roth conversions. So with this new found Roth freedom, what planning opportunities are available to maximize investment and tax value?
The reasons for Roth conversions can vary widely; some strategies are more appropriate for high net worth individuals, while others can help people of very modest means. Let us explore some of these strategies and see which ones might be applicable to your situation.
Income Smoothing
When you have a year or period of years where you anticipate lower earned income, Roth conversions can help smooth out the annual income number to take advantage of lower income tax brackets in low earning years.
For example, if someone goes back to school, takes time off of work, or retires before pensions and Social Security payments begin, Roth conversions can raise income during the low earning years to take advantage of marginal rates which could be much lower than if that income is paid out of the IRA at a later date on top of other income.
“Back Door” Roth Contributions
Though high income earners are not allowed to contribute to Roth IRA accounts annually, there is no income limit on making non-deductible IRA contributions. There is also no income limit on making Roth conversions. Thus, high income earners can make non-deductible contributions and immediately convert them to Roth accounts. Since there is no gain and no deduction was taken on the contribution, the conversion produces no taxable income. It is a “back door” to making Roth contributions.
The major hurdle to this strategy is that if an individual has a traditional, SEP, or SIMPLE IRA, he must aggregate all accounts together to calculate the taxable portion. So if you have $5,000 in a non deductible IRA, $45,000 in an IRA and make a $5,000 conversion, regardless of which account you convert, only 10% ($5,000 of $50,000 total) will be considered tax free on the conversion. Accounts are aggregated by individual, so a spouse without an IRA could still benefit from this strategy even if the other spouse has an existing IRA.
Increase Retirement Savings
Take, for instance, a $1,000,000 traditional IRA example. After paying tax (35%) on the distributions, the value may only be $650,000 after Uncle Sam gets his share. If that IRA is converted to a Roth, then the balance is still $1,000,000, but because the Roth is tax-free, the value to the owner is much higher than it was before.
In this example, the conversion has boiled down to a large $350,000 retirement plan contribution from after-tax assets. The Roth has a higher value than the traditional IRA but no annual contribution limits were used for the conversion. Just like an employee defers taxable income to fund an IRA, the conversion uses after-tax assets to fund the conversion and increase the value of the retirement account.
Social Security Taxation Avoidance
Many modest income retirees can find themselves in a tax squeeze involving Social Security benefits. Social Security is only taxable if other sources of income are high enough to exceed specific thresholds. Once that income threshold is crossed, Social Security income, which would not have been taxable, is made taxable by other income sources.
To illustrate, a retiree may have Social Security benefits of $2,000 per month, have no pension, but have a traditional IRA he can draw on for extra income. If he draws nothing from his IRA, he pays $0 in tax on his Social Security benefits. If he draws $3,000 per month from his IRA to live on, then 85% of the Social Security benefits become taxable. Therefore when calculating taxes, 85% of the Social Security benefits are added into the $36,000 of IRA distributions, for total taxable income of $56,400 per year in this example.
The retiree is only adding $3,000 to his monthly income, but is paying income tax on $4,700 because 85% of his Social Security becomes taxable. It is not uncommon for retirees to face up to 40% effective tax for taking IRA distributions in this modest income range. Even if the retiree doesn’t need to take additional distributions from an IRA, at 70 ½, all taxpayers are required to take Required Minimum Distributions (RMD’s) from their traditional IRA accounts, which could push someone into this territory.
Roth IRA distributions, on the other hand, are not counted as income for this calculation, and RMDs are not required for Roth IRAs. You are not forced to take taxable income in the future and when you do take distributions; it will not subject your Social Security to being taxable.
Estate Shrinkage
For those facing a possible estate tax, a Roth conversion can shrink the size of a taxable estate, but not decrease the value of the estate. Take, for instance, the same $1,000,000 traditional IRA example used previously. If that IRA is converted to a Roth, then the balance for estate tax purposes is still $1,000,000.
The conversion creates a large tax bill which will be paid with other assets. By “pre-paying” the tax on the IRA, those other assets (used to pay the tax) have been removed from the estate. The Roth IRA is now after-tax and worth more than the $1,000,000 traditional IRA by approximately the tax paid on the conversion. If estate tax is a problem, paying income tax once is better than paying estate tax and then having the beneficiaries pay income tax when they withdraw the asset.
No matter what your situation, it may make sense to look at Roth conversions. Some strategies take years to execute, some can be performed in one quick conversion. You should look carefully at your situation and consider if Roth conversions make sense for you.
Posted by Ben Gurwitz on 12th January, 2012 | Comments | Trackbacks | Permalink
Tags: Tax Planning, Estate Planning, Retirement Accounts, Investments, Financial Planning, Social Security, Jan 12
Retirement Planning: Better With an Advisor?
The past few years have been harsh ones for retirees as a volatile stock market and economic uncertainty have made retirement planning especially challenging. That said, it is important not to neglect one of the most important tasks in successful preparation for your later years: conducting a retirement needs calculation to estimate how much money you will need for ongoing expenses.
Unfortunately, more than one-third of retirees with financial advisors had not estimated how much money they would need to maintain their current standard of living throughout their retirement. 1 This is a glaring omission because research has shown that those who have done a retirement needs calculation are likely to be more confident that they are accumulating enough assets. 2 They also are likely to have higher savings goals, which may be an indication that completing the needs calculation has given them a realistic assessment of how much they need to save.
Help From a Financial Advisor
If you are uncertain about how to conduct a needs calculation, it may be helpful to consult a financial advisor. More than 6 in 10 (61%) of retirees who participated in a recent survey had a relationship with a personal financial advisor. Retirees with financial advisors were more likely to engage in some aspect of financial planning and were somewhat more willing to take a degree of investment risk, but not to the point of aggressively managing household assets.
If a financial advisor is not available to you, an online calculator or a worksheet can help you estimate how much you will need. Surprisingly, when workers polled by the Employee Benefit Research Institute were asked how they went about conducting a needs calculation, 42% said they guessed and 9% read or heard how much was needed. 2 These offhand estimates may not be as reliable as a financial advisor or a tool that takes into consideration your current level of retirement assets, your estimated expenses, your time horizon, and other variables.
There's no question that the past few years have heightened feelings of uncertainty, but try not to let these feelings cloud your planning. Doing the math of retirement is a wise investment of time and effort in your financial future.
Source/Disclaimer:
1 Sources: International Foundation for Retirement Education; LIMRA; the Society of Actuaries, "The Financial Recovery for Retirees Continues: The Impact of the 2008-2011 Financial Crisis," 2011.
2Source: Employee Benefit Research Institute, Issue Brief, March 2011.
December 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.
High Yields Prove Elusive
Historically, many retirees and preretirees have looked to their portfolios as a potential source of income. In the current environment, finding these sources is no easy task. Ten-year U.S. Treasury bonds yield only 2.2%, and dividend-paying stocks within the S&P 500 are yielding 2.5%. 1
But there are opportunities for higher yields that investors may want to consider. Higher yields can mean greater risk, so it is important to understand risk and potential return with any investment.
Potential Sources
When looking for yields that currently exceed U.S. Treasury securities, you may want to review the following:
- As of September 30, 2011, corporate high-yield bonds, as measured by the Merrill Lynch High-Yield Master II Index, generated yields of 9.54%. Keep in mind that the yields of some corporate high-yield bonds compensate investors for default rates that historically have been higher than the broader fixed-income universe. 2
- Higher-yielding sectors within the S&P 500 have included Telecommunication Services, which yielded 5.59% as of September 30, 2011, and Utilities, which yielded 4.27%. 3 Standard & Poor's believes that expense control and broadband growth will support dividends for the Telecommunication Services sector. For Utilities, Standard & Poor's anticipates that higher revenue among electric utilities and expanding gross margins for gas utilities will cause the sector's dividend yield to be maintained.
- Emerging market sovereign debt, as measured by the Merrill Lynch Emerging Market Sovereign Bond BBB U.S. Dollar Index, yielded 4.65% as of September 30, 2011. Emerging market debt provides exposure to markets where economic growth currently exceeds the developed world while avoiding troubled European markets. 4
Yield and Your Portfolio
The following tips may help you evaluate higher-yielding investments at a time when finding yield remains a challenge.
- Review an investment's exposure to risk as well as its potential return. High-yield bonds historically have experienced higher default rates than investment-quality issues. Keep in mind that bond prices decrease when interest rates rise, opening bondholders to downside risk if inflation increases and market interest rates rise from their current lows. Holding a bond to maturity eliminates this secondary market risk.
- Diversify sources of yield. Relying too much on one or two income-oriented securities can leave you exposed to unanticipated changes in the financial markets.
- Consider your asset allocation. Since yield is available from both stocks and bonds, you may be able to create a high-yielding portfolio within the framework of your desired asset allocation. Within a stock allocation, equities within the S&P 500 Dividend Aristocrats have increased dividends every year for at least 25 years. Municipal bonds may present tax benefits for fixed-income investors. 5
The variety of yield sources available presents opportunities to craft an income-generating portfolio suitable for many different risk profiles and time horizons.
Source/Disclaimer:
1Yields are as of September 30, 2011. Government bonds and Treasury bills are guaranteed by the U.S. government as to the timely payment of principal and interest, and if held to maturity, they offer a fixed rate of return and fixed principal value.
2Lower-quality debt securities involve greater risk of default or price changes due to changes in the credit quality of the issuer. They may not be suitable for all investors.
3Investments in specialized industry sectors have additional risks, which are outlined in the prospectus.
4Emerging markets are generally more volatile than the markets of more-developed foreign nations, and therefore you should consider this increased market risk carefully before investing. Investors in international securities may be subject to higher taxation and higher currency risk, as well as less liquidity, compared with investors in domestic securities.
5Municipal bonds are federally tax free, but other state and local taxes may apply.
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.
How to Get Paid on Time
With the current economic conditions, the collection of accounts receivables is becoming more and more of a challenge. Strengthening your collection procedures may allow you to improve collection rates and shorten the aging days of your accounts receivables.
The following suggestions will help your business improve its cash flow and tighten up its credit and collections policies. Some of the tips discussed here may not be suitable for every business, but can serve as general guidelines to give your company more financial stability.
Define Your Policy. Define and stick to concrete credit guidelines. Your sales force should not sell to customers who are not credit-worthy, or who have become delinquent. You should also clearly delineate what leeway sales people have to vary from these guidelines in attempting to attract customers. Tip: You should have a system of controls for checking out a potential customer's credit, and it should be used before an order is shipped. Further, there should be clear communication between the accounting department and the sales department as to current customers who become delinquent.
Clearly Explain Your Payment Policy. Invoices should contain clear written information about how much time customers have to pay, and what will happen if they exceed those limits. Tip: Make sure invoices include a telephone number and website address so customers can contact you with billing questions. Also include a pre-addressed envelope. Tip: The faster invoices are sent, the faster you receive payment. For most businesses, it's best to send an invoice with a shipment, rather than afterward in a separate mailing.
Follow Through on Your Stated Terms. If your policy stipulates that late payers will go into collection after 60 days, then you must stick to that policy. A member of your staff (but not a salesperson) should call all late payers and politely request payment. Accounts of those who exceed your payment deadlines should be penalized and/or sent into collection, if that is your stated policy.
Train Staff Appropriately. The person you designate to make calls to delinquent customers must be apprised of the seriousness and professionalism required for the task. Here is a suggested routine for calls to delinquent payers: - Become familiar with the account's history and any past and present invoices.
- Call the customer and ask to speak with whoever has the authority to make the payment.
- Demand payment in plain, non-apologetic terms.
- If the customer offers payment, ask for specific dates and terms. If no payment is offered, tell the customer what the consequences will be.
- Take notes on the conversation.
- Make a follow-up call if no payment is received and refer to the notes taken as to any promised payments.
Important Consumer Disclosure
Financial Life Advisors, LLC ("FLA") is a state registered investment adviser located in the State of Texas. FLA and its representatives are in compliance with the current registration requirements imposed upon state registered investment advisers by those states in which FLA maintains clients. FLA may only transact business in those states in which it is registered, or qualifies for an exemption or exclusion from registration requirements. FLA's web site is limited to the dissemination of general information regarding its investment advisory services to United States residents residing in states where providing such information is not prohibited by applicable law. Accordingly, the publication of FLA's web site on the Internet should not be construed by any consumer and/or prospective client as FLA's solicitation to effect, or attempt to effect transactions in securities, or the rendering of personalized investment advice for compensation, over the Internet. Furthermore, the information resulting from the use of tools or other information on this Internet site should not be construed, in any manner whatsoever, as the receipt of, or a substitute for, personalized individual advice from FLA. Any subsequent, direct communication by FLA with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides. For information pertaining to the registration status of FLA, please contact the state securities law administrators for those states in which FLA is registered. A copy of FLA's current written disclosure statement discussing FLA's business operations, services, and fees is available from FLA upon written request. FLA does not make any representations as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to FLA's web site or incorporated herein, and takes no responsibility therefore. All such information is provided for convenience purposes only and all users thereof should be guided accordingly.
Some representatives of FLA are also securities licensed by several states with McNally Financial Services Corporation, an independent broker-dealer. Member FINRA/SIPC.
ACCESS TO THIS WEB SITE IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND WITHOUT ANY WARRANTIES, EXPRESSED OR IMPLIED, REGARDING THE ACCURACY, COMPLETENESS, TIMELINESS, OR RESULTS OBTAINED FROM ANY INFORMATION POSTED ON THIS WEB SITE OR ANY THIRD PARTY WEB SITE LINKED TO THIS WEB SITE.
ANY STATEMENTS CONTAINED HEREIN ARE NOT INTENDED OR WRITTEN BY THE UNDERSIGNED TO BE USED, AND NOTHING CONTAINED HEREIN CAN BE USED BY YOU OR ANY OTHER PERSON, (i) FOR THE PURPOSE OF AVOIDING PENALTIES THAT MAY BE IMPOSED UNDER FEDERAL TAX LAW, or (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY TRANSACTION OR MATTER ADDRESSED HEREIN.
This newsletter is intended to provide general information that is appropriate in certain situations. It is not intended to be used by the recipient for the purpose of avoiding federal tax penalties. The contents of this newsletter should not be acted upon without specific professional guidance. Please call us if you have questions.
|
