March 2010 Newsletter
March 9, 2010 by Jean Keener, CRPC, CFDP · Leave a Comment
The March 2010 Newsletter is now available. It includes an investment market update, Part II in my series on how to tap into your home equity in retirement, considerations in evaluating an early retirement offer, information on 2009 tax deduction for 2010 Haitian relief contributions, 2011 tax rate proposals found in the federal budget, credit card act provisions, and a reminder on the deadline to take advantage of the home buyers credit. Click here to read it.
Pension Max: Is it right for you?
December 15, 2009 by Jean Keener, CRPC, CFDP · Leave a Comment
If you’re near retirement and have a pension, you may be considering a pension max strategy. With all the variables involved, it can be challenging to determine if it’s really in your best interest.
First – what is pension max?
Pension max is used by married couples to increase their net retirement income while still protecting the surviving spouse’s income in the event the pension recipient dies first. Basically, the pension recipient elects a single life pension instead of one with a survivor benefit for their spouse. This results in a higher monthly pension benefit. Then the pension recipient purchases life insurance to allow the surviving spouse to replace the pension income in the event that the pension recipient dies first. In some situations, this approach can result in a higher net retirement income if the cost of the needed life insurance is less than the increased pension benefits.
Pension max always results in more premiums for the insurance company, but doesn’t always result in more income for you. How do you decide if it’s in your best interest?
First — at the risk of stating the obvious — if you’re not married, there’s no reason to consider it. Depending on your estate goals and health, there may be other strategies that make sense.
Second – the health and age of the pension recipient matters a great deal. If the pension recipient is in excellent health and can likely qualify for preferred life insurance rates, pension max has a lot better chance of being a good idea.
Third – you need to determine how much and what kind of life insurance is needed to replace the income. As the pension recipient gets older, less life insurance death benefit will be required to replace the pension income. Usually some combination of tiered term-life policies and a small amount of permanent insurance fit the bill.
Fourth – the surviving spouse should have an idea of how they will use the life insurance death benefit to replace the pension income. For many, a single-premium immediate annuity makes the most sense, however other draw-down investment scenarios can also be considered.
Fifth – you need to consider taxes in your calculations on both the life insurance benefit and the increased pension benefit.
- Life insurance death benefits are generally not subject to income taxes. With an unlimited marital exemption, the estate tax will not be an issue when the first spouse dies. However, depending on the overall size of the estate and the death benefit, it could be an issue when the second spouse dies.
- The increased pension benefit will be subject to income taxes. So when you’re comparing the net effect on your income, you need to calculate how much your pension will be worth after taxes because you will be paying the life insurance premiums with after-tax dollars. This is an easy area to ignore, but depending on your tax bracket the effect of taxes can make or break the plan.
Sixth – consider the convenience factor. If there’s just a very small financial benefit to using a pension max strategy in your situation, it may still make sense to forego it. You need to weigh the simplicity of just taking the pension against the extra effort of going through life insurance underwriting and paying the premiums ongoing.
If you’re seriously considering using a pension max strategy, it’s a good idea to have an uninterested third party talk through the analysis with you. A fee-only financial advisor who doesn’t have a big insurance commission at stake based on your decision will be able to offer objective advice. And even though you spend some money on the advice, it may help you save much more over the long term and at very least feel confident that you made the right decision based on your unique situation.
December 2009 Newsletter
December 3, 2009 by Jean Keener, CRPC, CFDP · Leave a Comment
The December 2009 newsletter is now available. It includes a market update, tips on tracking your expenses, year-end investing moves designed to save on taxes, and more. Click here to read the newsletter.
2010 Key Numbers
December 2, 2009 by Jean Keener, CRPC, CFDP · Leave a Comment
The key numbers guide from Forefield has been updated for 2010. Not a lot of changes from last year, but still a convenient reference. It includes limits on retirement plan contributions, tax brackets, tax credit and deduction phase-outs, social security benefits, medicare, and much more. 2010 Key Numbers
Buying a home to cash in on home buyers tax credit?
November 12, 2009 by Jean Keener, CRPC, CFDP · 2 Comments
You may have heard that the first-time home buying tax credit was extended through April 30 next year, and that it now includes a credit for some non-first-time home buyers also. For details on the extension and who is eligible, visit the IRS website.
This is great news if you fall into the eligible groups and were already planning to purchase a home. A tax credit is an actual dollar-for-dollar credit against your tax liability, as compared to a tax deduction which just reduces your taxable income. A deduction, depending on which tax bracket you’re in, saves you between 10% and 35% of the deduction. The credit saves you 100% of the credit amount. The home buying credit is also fully refundable, which means you can receive it even if it exceeds your tax liability.
Should you adjust the timing of your home purchase to take advantage of the credit?
Yes, this is a good idea. If it’s just a question of changing your timing by a few months to take advantage of the tax credit and there aren’t other substantial costs with the change, that makes all the sense in the world.
If you weren’t planning to purchase a home already, should this credit motivate you to take action?
Definitely not. If you weren’t planning to buy a home and aren’t financially ready for the purchase, this tax credit doesn’t significantly change that math.
For existing home owners, the costs of a move are too high to even come close to being offset by this credit. Consider real estate commissions, preparing your home to sell, closing costs on the new home, moving expenses, and ongoing increases in your utilities, maintenance and property taxes if you move to a larger home.
For potential first-time home buyers, the credit doesn’t significantly change whether home ownership is right for you. Yes, the $8,000 is a nice bonus. But it’s a small dent in the costs of owning a home over even the 3-year minimum required to not pay back any of the credit. The mortgage is just the beginning of the cost of home ownership – consider maintenance, repairs, yard work, and utilities that are typically higher in a home than an apartment. There’s also the property tax and insurance which for most first-time home buyers will be escrowed into their total mortgage payment, however it’s up to the home owner to catch up any shortfall in the amounts escrowed.
Bottom line, you should definitely take advantage of the home buyers credit if it fits in with your overall financial plan. The credit could even provide a good opportunity for you to jump-start your 2009 or 2010 IRA contributions, beef up your emergency fund, or start a 529 plan for your children’s college. But the credit shouldn’t tempt you to make a decision that will end up hurting you financially long-term. Make sure your math includes the long-term total cost of your move!
November 2009 Newsletter
November 5, 2009 by Jean Keener, CRPC, CFDP · Leave a Comment
The November newsletter is now available. It includes a market update, 2010 retirement plan contribution limits, and more. Click here to view it.
2009 Year-End Tax Planning Checklist
November 4, 2009 by Jean Keener, CRPC, CFDP · Leave a Comment
Reviewing your tax situation for the year when you still have time to do something about it is always a good idea. You have many more options to affect your tax liability by acting before the year ends. This year, it’s still important to review all the regular opportunities available every year, but we also have many unique opportunities for 2009 that can save you additional money.
Some of the standard areas to consider
If you think your tax bracket next year will be the same or lower than your tax bracket this year, look for opportunities to defer income to 2010 and accelerate deductions. However, if you are subject to the Alternative Minimum Tax, give this special analysis because these actions don’t always work to your benefit with the AMT.
Max out employer retirement plan contributions before year end — $16,500 for a 401(k), plus an extra $5,500 for those 50+ before December 31. Make IRA contributions prior to April 15.
If you are self-employed, set up a retirement plan if you haven’t already done so.
Review the amount you set aside for next year in your employer’s health flexible spending account (FSA) if you set aside too little or too much for this year. Don’t forget that you can set aside amounts to get tax-free reimbursements for over-the-counter drugs.
If you become eligible to make health savings account (HSA) contributions in December of this year, you can make a full year’s worth of deductible HSA contributions for 2009.
Those facing a penalty for underpayment of federal estimated tax may be able to eliminate or reduce it by increasing their withholding before year-end.
You may wish to realize losses in your investment portfolio. Up to $3,000 can be deducted from your income each year.
You can save gift and estate taxes by making gifts within the annual gift tax exclusion before the end of the year. You can give $13,000 in 2009 to an unlimited number of individuals but you can’t carry over unused exclusions from one year to the next. The limit applies to each person, so a married couple can give $26,000 total to each person.
Some of the special consideration for 2009
Required Minimum Distributions suspended for 2009 — If you already took an RMD for 2009, you may be able to roll over the RMD to the same (or to a different) IRA or eligible retirement plan–you generally have until the later of 60 days from the time you took the distribution or November 30, 2009.
Roth IRA 2010 conversions – It’s worth looking ahead to 2010 when special rules will apply to Roth conversions. These rule changes might influence your actions now by planning to defer deductions to offset future taxes or by making non-deductible traditional IRA contributions now in anticipation of converting them later. Click here to read my blog post on 2010 Roth conversions.
Depreciation rules for 2009 allow an additional 50% first-year depreciation deduction for qualifying property purchased for use in your business on or before December 31. In lieu of depreciation, Section 179 deduction rules allow for the deduction, or “expensing,” of up to $250,000 of the cost of qualifying property placed in service during 2009. Currently, that limit is scheduled to drop to $125,000 (adjusted for inflation) in 2010.
A tax credit of up to $8,000 is available in 2009 for qualified first-time homebuyers (only homes purchased before December 1, 2009, qualify).
The first $2,400 of unemployment compensation received in 2009 is excluded from income for federal income tax purposes.
If you itemize deductions, 2009 is the last year you’ll have the option to deduct state and local sales tax instead of state and local income tax (as the law currently stands).
Individuals who do not itemize deductions are able to claim an additional standard deduction of up to $500 ($1,000 for married couples filing jointly) for real estate property taxes paid for 2009, the last year this deduction will be available (as the law currently stands).
The temporary deduction for sales and excise tax relating to the purchase of a qualified new automobile, light truck, or motorcycle applies to vehicles purchased through December 31, 2009.
The above-the-line (maximum $4,000) deduction for qualified tuition and related expenses expires at the end of 2009, as does the above-the-line deduction for up to $250 in out-of-pocket classroom expenses paid by educational professionals.
Individuals age 70½ or older have only until December 31, 2009, to make charitable contributions of up to $100,000 directly from an IRA to a qualified charity, without including the distribution in income.
Special considerations for high income earners
Many expect top tax rates on ordinary income to increase after 2010, making long-term deferral of income less advantageous. Long-term capital gains rates could go up as well, so it may make sense for some to accelerate substantial profits into this year instead of a few years down the road. It also makes sense to proceed with caution in any Roth conversion strategy to determine the most advantageous year or years to pay the conversion tax. This decision can be delayed until you file your 2010 taxes by which time hopefully there will be more clarity on this issue.
There is some good news for high-income earners. There will no longer be an income based reduction of most itemized deductions, and there also won’t be a phase-out of personal exemptions. Traditional IRA to Roth IRA conversions will also be allowed regardless of a taxpayer’s income.
Consult your tax advisor
With all of the items on this checklist, there are potentially many nuances and additional rules not listed here. It’s important to consult with your tax advisor prior to implementing any of these suggestions.
Partial Roth Conversion Strategy
October 13, 2009 by Jean Keener, CRPC, CFDP · Leave a Comment
When people find out how much tax they would have to pay to convert their IRA from traditional to Roth, it’s often times a conversion show stopper. Even if all the analysis shows that conversion would be clearly beneficial to their after-tax retirement income levels or provide estate planning benefits, there’s a gigantic psychological hurdle with writing a check to the IRS sooner rather than later. However, the conversion decision can become more attractive when you realize it’s not an all or nothing decision. You can choose to convert just part of your traditional IRA balance.
How do you decide how much to convert?
One reasonable way of determining how much to convert is doing enough to take you to the top of your current tax bracket without going into the next one. You might also determine how much of a tax bill you would be willing to pay, and then calculate the conversion amount based on that. For most, one of these two options will create the most appealing results.
There is a third option in the “fancy financial footwork” category.
This third option will result in far too much paperwork for many individuals to want to deal with it, especially for a smaller traditional IRA balance. But if you have a larger IRA – say $50,000 or more – the extra work might be worth the tax savings. Conversion is not an irrevocable decision until you get to the tax filing deadline of the next year (October 15 for most people). This 21-month window from January 2010 until the deadline to “recharacterize” the conversion creates a Roth Segregation Opportunity, pioneered by David Marotta of Marotta Wealth Management in Virginia and written up in a recent Financial Planning Magazine article.
Using the Roth Segregation Strategy, you convert your entire traditional IRA balance in January 2010. Let’s say the balance is $100,000 for easy math. Instead of putting the entire conversion in one account, you put $20,000 in each of 5 accounts. Each of these 5 accounts is invested in a different equity asset class – you might do 20% large cap growth, 20% large cap value, 20% small cap, 20% developed international, and 20% emerging markets. Then, around the beginning of October 2011, you assess which of these asset classes has performed the best. You keep the converted IRA with the best performance and recharacterize each of the other 4 back to traditional IRAs. This limits your tax liability (payable on 2011 and 2012 tax returns) to just the taxes on the $20,000. Of course, if multiple asset classes performed extremely well, you might choose to keep more of the conversions. Or if they all declined in value, you would likely recharacterize them all.
This strategy is not a simple one. It requires a lot of analysis and rigorous tracking of the paperwork to ensure that everything is completed properly. You would also want to ensure that going with such an aggressive equity allocation in your IRA over the 21-month period made sense within the larger context of your portfolio, time horizon, and risk tolerance. And for those that plan to do a full conversion vs. a partial, there’s no benefit to setting up all the different accounts.
But for those of you who relish a little financial creativity and don’t mind complexity, this can be a pretty cool opportunity to analyze and implement – and unique to the 2010 opportunity to spread taxes over 2011 and 2012.
October 2009 Newsletter
October 2, 2009 by Jean Keener, CRPC, CFDP · Leave a Comment
The October newsletter is now available. It includes a reminder about the October 15 deadline to recharacterize 2008 Roth IRA conversions, a market update, how to calculate your net worth and why net worth is the financial number to watch, and more. To read the newsletter, click here.
Roth conversion as estate planning technique
September 28, 2009 by Jean Keener, CRPC, CFDP · Leave a Comment
The 2010 lifting of income limits for Roth IRA conversions creates a sizable opportunity to reduce estate taxes. We’ve already discussed Roth IRA conversion basics, and who might want to convert. But if your estate is potentially subject to the estate tax at your death, you have an additional reason to take a close look at this opportunity.
For 2009, the estate tax exemption is $3.5 million. Under current law, the estate tax is scheduled to be completely revoked for 2010 and then in 2011 revert back to a $1 million per person exemption. Very few people think that the current law will stand as is. But no one knows right now what congress will do. So, for planning purposes, it’s prudent to consider Roth IRA conversion if your estate is potentially at or even near current estate tax levels. If you’re not sure about your estate, there’s a neat little calculator at SmartMoney.com.
How does converting help?
When you pass money in a traditional IRA to your heirs, you are passing the funds pre-income-tax. When you pass money in a Roth IRA, you are passing post-income-tax funds. Either way, the total being passed counts toward your taxable estate. So if you pay the taxes on the IRA funds before your death by converting traditional IRA funds to Roth, you reduce your taxable estate by the amount of the income taxes paid.
Let’s look at an example simplified for the case of illustration.
Suppose Mr. Smith has $5 million in assets that he will be passing to his son when he dies. Using the $3.5 million exemption, $1.5 million will be subject to the estate tax, and estate taxes would be approximately $675,000. $1 million of these assets are in a traditional IRA. Mr. Smith is in the 35% tax bracket.
If Mr. Smith converts the $1 million traditional IRA to a Roth, he will pay $350,000 in income taxes for the conversion, reducing his estate to $4,650,000. After conversion, only $1,150,000 will remain subject to the estate tax, and his estate tax will go down to $517,500 – a savings of approximately $157,500.
Other considerations with this strategy:
- What tax bracket is the beneficiary in?
- How much do we expect the IRA to grow between conversion and estimated life expectancy?
- What other estate planning techniques are available to Mr. Smith to otherwise reduce estate taxes?
In any case, if your assets potentially make your estate subject to the estate tax and you have a traditional IRA, converting to a Roth IRA merits consideration as an estate planning technique.