An array of topics that can affect the growth and sustainability of your current and future assets.
Monday, October 22, 2012
Using 529 Plans to Invest for College and Manage Wealth
Paying for a child’s or grandchild’s college education is an expensive proposition, even for many high-net-worth Americans. Today’s elite institutions promise graduates a rewarding future, but at a cost that more often than not extends well into six figures. Enter the 529 plan, a tax-advantaged investment vehicle generally available to families regardless of their income level. For affluent parents and grandparents, a 529 plan offers a variety of potential benefits—including some that go beyond the scope of college planning. A 529 plan may in fact play an integral role in an estate plan.
First and Foremost, a College Savings Tool ...
Before you consider the potential role of a 529 plan in your estate plan, it is important to understand a few basics.
• There are two types of 529 plans—prepaid tuition plans, which let you lock in tomorrow’s tuition at today’s rates, and college savings plans, which let you choose from a menu of investments and offer more return potential, as well as risk. Both types of plans are generally sponsored by a state government and administered by one or more investment companies. (Tax law also permits certain educational institutions to sponsor prepaid tuition plans).
• Many 529 plans offer age-based asset allocation portfolios that become more conservative as the beneficiary grows older. Others let account owners choose from individual investment options to create a customized portfolio.
• Originally, 529 plans offered the benefit of tax-deferral—taxes on earnings were not due until withdrawal and then only at the beneficiary’s rate. But a few years ago Uncle Sam sweetened the pot, and now qualified withdrawals are federally tax free.
• Eligibility to contribute to a 529 plan is not limited by age or income. In addition, total plan contribution limits often exceed $200,000.
• Withdrawals can be used to pay for undergraduate or graduate school expenses. Withdrawals used for purposes that fall outside of the “qualified education expenses” category are subject to ordinary income taxes and a 10% penalty tax.
... But With Valuable Wealth Transfer Potential
The IRS clearly had college planning in mind when it drafted Section 529 of the Internal Revenue Code. However, it also left the door open to use 529 plans as wealth transfer tools. That is because a contribution to a 529 plan is considered a completed gift from the donor to the beneficiary named on the account, even though the account owner, not the beneficiary, maintains control over the money while it is in the account. Tax rules permit you to give $13,000 (indexed to inflation) to as many individuals as you choose each year, free from federal gift taxes. Couples can give $26,000 without incurring taxes. As a result, one method of reducing a taxable estate is to make scheduled gifts up to the tax-free limits each year. For instance, you might give $13,000 to each grandchild on an annual basis.
But there is more. Under special rules unique to 529 plans, donors looking to remove large sums of money from their taxable estates can make five years’ worth of $13,000 gifts in one year—that’s $65,000 per individual donor or $130,000 per couple. Of course, you would not be able to make additional taxable gifts to that beneficiary during the five-year period. And if you use the five-year averaging election and die before the five years are up, a prorated portion of the contribution may be considered part of your taxable estate.
But the wealth transfer potential can be substantial. For instance, an individual who has five grandchildren could immediately remove up to $325,000 from his or her taxable estate by contributing the money to five separate 529 plan accounts. Five years later, he or she could do it again.
You Stay in Control
It’s worth emphasizing: Although the assets contributed to a 529 plan are no longer considered part of your taxable estate, you still exercise control over the money. You decide how it will be invested—within the confines of the plan’s available investment options—and when it will be withdrawn. You also have the right to change beneficiaries, in the event that the original beneficiary decides not to attend college, for example. And doing so generally will not trigger tax consequences if you choose a beneficiary who is a member of the original beneficiary’s family. (As spelled out in Section 529, qualified family members include the beneficiary’s brothers, sisters, mother, father, sons, daughters, nieces, and nephews, among others.) If there is not another suitable beneficiary, you also have the option of closing the account and taking the money back, although earnings will be subject to income taxes, as well as a 10% penalty.
When choosing a 529 plan, you will need to look beyond estate planning considerations. There are dozens of plans available and their features and rules can vary greatly. To help narrow down the choices, consider working with a qualified financial professional. And be sure to consult with an estate planning attorney or tax professional before making any decisions that could affect your tax liability.
Prior to investing in a 529 Plan investors should consider whether the investor's or designated beneficiary's home state offers any state tax or other benefits that are only available for investments in such state's qualified tuition program.
_________________________________
1Asset allocation does not assure a profit or protect against a loss.
Consult your financial advisor, or me, if you have any questions.
Because of the possibility of human or mechanical error by S&P Capital IQ Financial Communications or its sources, neither S&P Capital IQ 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 S&P Capital IQ Financial Communications be liable for any indirect, special, or consequential damages in connection with subscribers’ or others’ use of the content.
Thursday, July 26, 2012
Your Second Wind—Starting a New Business in Retirement
For generations past, retirement represented an extended period of leisure time punctuated by occasional games of golf and bridge. But today, with lengthening life expectancies and dwindling pensions, many Americans are looking to retirement as an opportunity to start a new business.
Senior Start-ups: Common Characteristics
Older entrepreneurs differ from their younger counterparts in several critical ways. For one, seniors are usually in a much better financial position than younger entrepreneurs. Their bigger financial cushion—retirement packages, savings or home ownership—affords them flexibility in the initial stages of a start-up, where funding is often critical. Because they can often rely on other sources for current income, they are in a better position to take greater entrepreneurial risks. Start-up funding may also be easier to come by for seniors, who can draw from personal savings and a lifetime of business and professional contacts. Senior start-ups may also be looked on more favorably by lenders, who often associate older entrepreneurs with a lower risk of default.
Creativity and business acumen are also key characteristics of elder entrepreneurs. Older entrepreneurs often possess valuable intangible assets, such as a broad network of contacts, professional credibility and investment experience. Having been tested again and again in their lives, they may be less afraid of failure or worried about what others will think. Instead of that urgency to “make it,” they get satisfaction from the process of building their companies.
What Color Is Your Parachute?
The type of businesses started by seniors varies widely. Consultancies, small retail businesses and bed-and-breakfast establishments are perennial favorites. For many, web-based businesses offer particular appeal, since they can be operated right out of your home in the early stages, often requiring no more than a high-speed Internet connection and a phone line. While most senior start-ups are related to an individual’s former career, some break out into completely new territory. This is often the case with “serial” entrepreneurs—those who have started many businesses over their lives and are experts at the start-up process itself. Whatever business you might consider, make sure to first do your homework. Talk to owners of similar businesses and scope out the market for such products or services in your area. Then, take the time to draft a formal business plan.
Not for Everybody
As attractive as starting a new business in retirement may sound, there are several considerations you should bear in mind before taking the leap. Start-ups can be physically and emotionally draining for a retiree. Seniors tend to work fewer hours and take more vacations than their younger counterparts. Ask yourself: Are you willing or able to work the long hours that may be required in a fledgling business? There is also the issue of health to consider. For seniors, health problems can come at any time. Even if you are in top shape, you should factor in contingencies for unexpected health issues for yourself and your spouse.
Then there’s financial vulnerability. The real possibility of failure and money loss is much more significant at the age of 60 or 65 than at 30 when there is ample time to rebuild your assets and start over. Seniors also rely much more on personal investments to supply a portion of their income. For these reasons, seniors are advised not to sink too great a portion of their investment portfolio into a new business and should avoid using personal assets, such as a home, as loan collateral.
Successful Start-up Tips:
• Build on already established contacts and expertise. Seniors have a distinct advantage over younger entrepreneurs in their experience and long-established business network, which can give them a competitive advantage in virtually any business.
• Start small. When starting up a new business in retirement, many begin with a small consultancy and gradually work their way into a full-blown business. This will give you time to assess whether you are willing or able to take on another full-time career.
• Don’t bet the farm. If you're retired, you probably rely on personal investments for a portion of your income. Consider your income needs before investing a portion of your savings in a new business, and think twice before taking on any personal debt.
Popular Choices
Some popular businesses among retirees include:
• Adult day care
• Driving service
• Home handyman
• Sales
• Real estate agent
• Business consultant
• Home/pet sitting
• Arts/crafts
This article was is not intended to provide specific investment advice or recommendations for any individual. Consult your financial advisor, or me, if you have any questions.
Because of the possibility of human or mechanical error by S&P Capital IQ Financial Communications or its sources, neither S&P Capital IQ 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 S&P Capital IQ Financial Communications be liable for any indirect, special or consequential damages in connection with subscribers’ or others’ use of the content.
Tracking #1-071202
Senior Start-ups: Common Characteristics
Older entrepreneurs differ from their younger counterparts in several critical ways. For one, seniors are usually in a much better financial position than younger entrepreneurs. Their bigger financial cushion—retirement packages, savings or home ownership—affords them flexibility in the initial stages of a start-up, where funding is often critical. Because they can often rely on other sources for current income, they are in a better position to take greater entrepreneurial risks. Start-up funding may also be easier to come by for seniors, who can draw from personal savings and a lifetime of business and professional contacts. Senior start-ups may also be looked on more favorably by lenders, who often associate older entrepreneurs with a lower risk of default.
Creativity and business acumen are also key characteristics of elder entrepreneurs. Older entrepreneurs often possess valuable intangible assets, such as a broad network of contacts, professional credibility and investment experience. Having been tested again and again in their lives, they may be less afraid of failure or worried about what others will think. Instead of that urgency to “make it,” they get satisfaction from the process of building their companies.
What Color Is Your Parachute?
The type of businesses started by seniors varies widely. Consultancies, small retail businesses and bed-and-breakfast establishments are perennial favorites. For many, web-based businesses offer particular appeal, since they can be operated right out of your home in the early stages, often requiring no more than a high-speed Internet connection and a phone line. While most senior start-ups are related to an individual’s former career, some break out into completely new territory. This is often the case with “serial” entrepreneurs—those who have started many businesses over their lives and are experts at the start-up process itself. Whatever business you might consider, make sure to first do your homework. Talk to owners of similar businesses and scope out the market for such products or services in your area. Then, take the time to draft a formal business plan.
Not for Everybody
As attractive as starting a new business in retirement may sound, there are several considerations you should bear in mind before taking the leap. Start-ups can be physically and emotionally draining for a retiree. Seniors tend to work fewer hours and take more vacations than their younger counterparts. Ask yourself: Are you willing or able to work the long hours that may be required in a fledgling business? There is also the issue of health to consider. For seniors, health problems can come at any time. Even if you are in top shape, you should factor in contingencies for unexpected health issues for yourself and your spouse.
Then there’s financial vulnerability. The real possibility of failure and money loss is much more significant at the age of 60 or 65 than at 30 when there is ample time to rebuild your assets and start over. Seniors also rely much more on personal investments to supply a portion of their income. For these reasons, seniors are advised not to sink too great a portion of their investment portfolio into a new business and should avoid using personal assets, such as a home, as loan collateral.
Successful Start-up Tips:
• Build on already established contacts and expertise. Seniors have a distinct advantage over younger entrepreneurs in their experience and long-established business network, which can give them a competitive advantage in virtually any business.
• Start small. When starting up a new business in retirement, many begin with a small consultancy and gradually work their way into a full-blown business. This will give you time to assess whether you are willing or able to take on another full-time career.
• Don’t bet the farm. If you're retired, you probably rely on personal investments for a portion of your income. Consider your income needs before investing a portion of your savings in a new business, and think twice before taking on any personal debt.
Popular Choices
Some popular businesses among retirees include:
• Adult day care
• Driving service
• Home handyman
• Sales
• Real estate agent
• Business consultant
• Home/pet sitting
• Arts/crafts
This article was is not intended to provide specific investment advice or recommendations for any individual. Consult your financial advisor, or me, if you have any questions.
Because of the possibility of human or mechanical error by S&P Capital IQ Financial Communications or its sources, neither S&P Capital IQ 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 S&P Capital IQ Financial Communications be liable for any indirect, special or consequential damages in connection with subscribers’ or others’ use of the content.
Tracking #1-071202
Monday, June 4, 2012
Good Debt, Bad Debt: Keys for Knowing the Difference
Today debt and instant credit are part of our everyday lives. The convenience of instant credit, however, has taken its toll. Many individuals use credit cards to spend more than they earn. Some, who never use credit, can be denied a loan or credit when they have a justifiable use for it. Using credit establishes a history of financial responsibility: Until you establish a credit history, your chances of qualifying for an important loan, such as a mortgage, are greatly reduced.
Where is the balance between using credit wisely and staying out of overwhelming debt? Let’s look at the facts and some pros and cons.
Installment Debt
Debt comes in many forms, and most types help us in our daily lives -- when used responsibly. For instance, the money borrowed to purchase large-ticket items, such as a home or a new car, is called installment debt: The debtor pays a portion of the total at regular intervals over a specified period of time. At the end of that period, the loan with interest is paid off.
Installment debt allows you to purchase items at a competitive interest rate: for example, 3% to 7% for a 30-year home mortgage and 6% to 9% for a car loan. The loan is paid back in monthly installments of a fixed amount that remains constant over the life of the loan. At first, most of the monthly payment consists of interest. In later years, principal begins to be paid down.
Installment debt is easily budgeted, and the debt is eliminated on a predetermined date. Even for those who may actually have the cash to purchase the desired item, installment debt can make financial sense if you can earn a higher return (after taxes) on your investment of cash than you must pay on your installment debt.
Revolving Credit
A revolving line of credit is made available to you for use at any time. Examples of revolving credit are credit cards such as Visa, MasterCard and department store cards. When you apply for one of these cards, you receive a credit limit based on your credit payment history and income. When you use the credit line, you must make monthly minimum payments based on the total balance outstanding that month. Some lines of credit will also have an annual account fee.
While revolving credit is a convenient way to borrow, it can also become an endless pit of minimum payments that barely cover the interest due. Many cards charge annual rates of interest of 18% or higher. As you pay off your debt, the minimum payment is also reduced, thus extending your payoff period and, consequently, the interest you pay. Paying just the minimum due on a $2,000 credit card loan could mean making monthly interest payments for 10 or more years!
Revolving credit, in addition to being convenient, eliminates the need to carry a lot of cash and can help establish you as a creditworthy risk for future loans. But some people yield to the temptation that the convenience of credit cards offers. Impulse buying, failing to compare costs and purchasing large items you can’t afford are all downfalls brought on by always-available purchasing power. Spending more than you earn in any given period is a dangerous practice at best, but doing it over an extended period of time can be financial suicide.
Installment Debt vs. Revolving Debt
(Lower interest rates and an amortizing repayment schedule can make installment debt a much cheaper alternative to revolving credit.)
Installment Revolving
Beginning Balance $2,500 $2,500
Interest Rate 8.0% 18.0%
Years to Repay 4 19.3*
Interest Cost $430 $4,829
*Paying the higher of 2% minimum monthly payment or $25.
Using Credit Wisely
To use credit intelligently, start by examining the terms of the card(s) you are currently using. Keeping track of your cards, their rates and your current balances will help you to be aware of how you use credit cards. Increased competition in recent years has led some credit card companies to offer enticing features to attract new cardholders, including no annual fees and low interest rates for an introductory period. (And credit card companies sometimes will give their introductory rates to existing cardholders so that they won’t transfer their balances to another credit card company.)
Eliminating Credit Card Debt
If you think you may have too much credit card debt, begin to address it by honestly evaluating your spending habits. Examine your existing expenses to analyze how your money is spent. You will most likely be able to identify the problem areas where you are more likely to spend too much with credit cards. Then, based on your current spending practices, create a realistic budget to pay off your credit card debt in the shortest time possible while not adding any more debt to it. For assistance, you may want to turn to your financial advisor, who can help you to allocate your resources wisely to address your credit card debt.
As the aging baby boomers get closer to their peak earning years, many are realizing the need to reduce debt and increase savings. Even though analyzing your spending habits and creating a budget to address your debt may seem a little overwhelming, the simplicity of the philosophy of the Depression era still stands: Never spend more than you earn. Once you have come to grips with this basic fact, managing your debt will become far easier and more rewarding.
This article is not intended to provide specific investment advice or recommendations for any individual. Consult your financial advisor, or me, if you have any questions.
________________________
Because of the possibility of human or mechanical error by S&P Capital IQ Financial Communications or its sources, neither S&P Capital IQ 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 S&P Capital IQ Financial Communications be liable for any indirect, special or consequential damages in connection with subscribers’ or others’ use of the content.
Tracking # 1-062613
Tuesday, April 24, 2012
Tax Strategies for Retirees
In this world nothing is certain except death and taxes. - Benjamin Franklin
That saying still rings true centuries after the former statesman coined it. Yet, by formulating a tax-efficient investment and distribution strategy, retirees may keep more of their hard-earned assets for themselves and their heirs.
Less Taxing Investments
Municipal bonds, or “munis” have long been appreciated by retirees seeking a haven from taxes and stock market volatility. In general, the interest paid on municipal bonds is exempt from federal taxes and sometimes state and local taxes as well (see table below). The higher your tax bracket, the more you may benefit from investing in munis.
It is also important to review which types of securities are held in taxable versus tax-deferred accounts. Why? Because at least through the end of 2012, the maximum federal tax rate on some dividend-producing investments and long-term capital gains is 15%. Work with your financial advisor to review your overall investment holdings and determine which investments might be best suited for tax-deferred accounts versus taxable accounts.
The Tax-Exempt Advantage: When Less May Yield More
Would a tax-free bond be a better investment for you than a taxable bond? To find out, compare the yields. For instance, if you were in the 25% federal tax bracket, a taxable bond would need to earn a yield of 6.67% to equal a 5% tax-exempt municipal bond yield.
Federal Tax Rate 15% 25% 28% 33% 35%
Tax-Exempt Rate Taxable-Equivalent Yield
4% 4.71% 5.33% 5.56% 5.97% 6.15%
5% 5.88% 6.67% 6.94% 7.46% 7.69%
6% 7.06% 8% 8.33% 8.96% 9.23%
7% 8.24% 9.33% 9.72% 10.45% 10.77%
8% 9.41% 10.67% 11.11% 11.94% 12.31%
____________________________________________________________
This hypothetical example is used for illustrative purposes only and does not reflect the performance of any specific investment. State, capital gains and alternative minimum taxes are not considered. This formula is only one factor that should be considered when purchasing securities and is meant to be used only as a general guideline when calculating the taxable equivalent yields on Municipal securities.
Which Securities to Tap First?
Another decision facing retirees is when to liquidate various types of assets. The advantage of holding on to tax-deferred investments is that they compound on a before-tax basis and therefore have greater earning potential than their taxable counterparts.
On the other hand, you will need to consider that qualified withdrawals from tax-deferred investments are taxed at ordinary federal income tax rates of up to 35%, while distributions -- in the form of capital gains or dividends -- from investments in taxable accounts are taxed at a maximum of 15%. (Capital gains on investments held for less than one year are taxed at regular income tax rates.) For this reason, it may be beneficial to hold securities in taxable accounts long enough to qualify for the 15% tax rate.
The Ins and Outs of RMDs
The IRS mandates that you begin taking an annual distribution from traditional IRAs and employer-sponsored retirement plans after you reach age 70½. The premise behind the required minimum distribution (RMD) rule is simple: The longer you are expected to live, the less the IRS requires you to withdraw (and pay taxes on) each year.
RMDs are calculated using a Uniform Lifetime Table, which takes into consideration the participant’s life expectancy based on his or her age. Failure to take the RMD can result in a tax penalty equal to 50% of the required amount.
TIP: If you will be pushed into a higher tax bracket at age 70½ due to the RMD rule, it may pay to begin taking withdrawals during your 60s.
Unlike traditional IRAs, Roth IRAs do not require you to take distributions at all during your lifetime and qualified withdrawals are tax free. For this reason, you may choose to begin withdrawing assets held in a Roth IRA after you have exhausted other sources of income. Be aware, however, that any named beneficiaries of a Roth IRA will be required to take RMDs following the rules that govern traditional IRAs after your death.
Estate Planning and Gifting
There are various ways to make the tax payments on your assets easier for heirs to handle. Careful selection of beneficiaries is one example. If you do not name a beneficiary, your assets could end up in probate, and your beneficiaries could be taking distributions faster than they expected. In most cases, spousal beneficiaries are ideal because they have several options that are not available to other beneficiaries, including the marital deduction for the federal estate tax.
Also, consider transferring assets into an irrevocable trust if you are close to the threshold for owing estate taxes. In 2012, the federal estate tax applies to all estate assets over $5.12 million, but this threshold is scheduled to revert to $1 million in 2013, unless Congress elects to extend it. Assets in an irrevocable trust are passed on free of estate taxes, saving heirs thousands of dollars.
TIP: If you plan on moving assets from tax-deferred accounts, do so before you reach age 70½, when RMDs must begin.
Finally, if you have a taxable estate, you can give up to $13,000 per individual ($26,000 per married couple) each year to anyone tax free.
Strategies for making the most of your money and reducing taxes are complex. Please meet with an estate attorney and/or a financial advisor to help you sort through your options. For specific tax advice, please see a tax professional.
_____________________
1Capital gains from municipal bonds are taxable and may be subject to the alternative minimum tax.
2Withdrawals prior to age 59½ are subject to a 10% penalty.
_____________________
This article is not intended to provide specific investment advice or recommendations for any individual. Consult your financial advisor, or me, if you have any questions.
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 subscribers’ or others’ use of the content.
In this world nothing is certain except death and taxes. - Benjamin Franklin
That saying still rings true centuries after the former statesman coined it. Yet, by formulating a tax-efficient investment and distribution strategy, retirees may keep more of their hard-earned assets for themselves and their heirs.
Less Taxing Investments
Municipal bonds, or “munis” have long been appreciated by retirees seeking a haven from taxes and stock market volatility. In general, the interest paid on municipal bonds is exempt from federal taxes and sometimes state and local taxes as well (see table below). The higher your tax bracket, the more you may benefit from investing in munis.
It is also important to review which types of securities are held in taxable versus tax-deferred accounts. Why? Because at least through the end of 2012, the maximum federal tax rate on some dividend-producing investments and long-term capital gains is 15%. Work with your financial advisor to review your overall investment holdings and determine which investments might be best suited for tax-deferred accounts versus taxable accounts.
The Tax-Exempt Advantage: When Less May Yield More
Would a tax-free bond be a better investment for you than a taxable bond? To find out, compare the yields. For instance, if you were in the 25% federal tax bracket, a taxable bond would need to earn a yield of 6.67% to equal a 5% tax-exempt municipal bond yield.
Federal Tax Rate 15% 25% 28% 33% 35%
Tax-Exempt Rate Taxable-Equivalent Yield
4% 4.71% 5.33% 5.56% 5.97% 6.15%
5% 5.88% 6.67% 6.94% 7.46% 7.69%
6% 7.06% 8% 8.33% 8.96% 9.23%
7% 8.24% 9.33% 9.72% 10.45% 10.77%
8% 9.41% 10.67% 11.11% 11.94% 12.31%
____________________________________________________________
This hypothetical example is used for illustrative purposes only and does not reflect the performance of any specific investment. State, capital gains and alternative minimum taxes are not considered. This formula is only one factor that should be considered when purchasing securities and is meant to be used only as a general guideline when calculating the taxable equivalent yields on Municipal securities.
Which Securities to Tap First?
Another decision facing retirees is when to liquidate various types of assets. The advantage of holding on to tax-deferred investments is that they compound on a before-tax basis and therefore have greater earning potential than their taxable counterparts.
On the other hand, you will need to consider that qualified withdrawals from tax-deferred investments are taxed at ordinary federal income tax rates of up to 35%, while distributions -- in the form of capital gains or dividends -- from investments in taxable accounts are taxed at a maximum of 15%. (Capital gains on investments held for less than one year are taxed at regular income tax rates.) For this reason, it may be beneficial to hold securities in taxable accounts long enough to qualify for the 15% tax rate.
The Ins and Outs of RMDs
The IRS mandates that you begin taking an annual distribution from traditional IRAs and employer-sponsored retirement plans after you reach age 70½. The premise behind the required minimum distribution (RMD) rule is simple: The longer you are expected to live, the less the IRS requires you to withdraw (and pay taxes on) each year.
RMDs are calculated using a Uniform Lifetime Table, which takes into consideration the participant’s life expectancy based on his or her age. Failure to take the RMD can result in a tax penalty equal to 50% of the required amount.
TIP: If you will be pushed into a higher tax bracket at age 70½ due to the RMD rule, it may pay to begin taking withdrawals during your 60s.
Unlike traditional IRAs, Roth IRAs do not require you to take distributions at all during your lifetime and qualified withdrawals are tax free. For this reason, you may choose to begin withdrawing assets held in a Roth IRA after you have exhausted other sources of income. Be aware, however, that any named beneficiaries of a Roth IRA will be required to take RMDs following the rules that govern traditional IRAs after your death.
Estate Planning and Gifting
There are various ways to make the tax payments on your assets easier for heirs to handle. Careful selection of beneficiaries is one example. If you do not name a beneficiary, your assets could end up in probate, and your beneficiaries could be taking distributions faster than they expected. In most cases, spousal beneficiaries are ideal because they have several options that are not available to other beneficiaries, including the marital deduction for the federal estate tax.
Also, consider transferring assets into an irrevocable trust if you are close to the threshold for owing estate taxes. In 2012, the federal estate tax applies to all estate assets over $5.12 million, but this threshold is scheduled to revert to $1 million in 2013, unless Congress elects to extend it. Assets in an irrevocable trust are passed on free of estate taxes, saving heirs thousands of dollars.
TIP: If you plan on moving assets from tax-deferred accounts, do so before you reach age 70½, when RMDs must begin.
Finally, if you have a taxable estate, you can give up to $13,000 per individual ($26,000 per married couple) each year to anyone tax free.
Strategies for making the most of your money and reducing taxes are complex. Please meet with an estate attorney and/or a financial advisor to help you sort through your options. For specific tax advice, please see a tax professional.
_____________________
1Capital gains from municipal bonds are taxable and may be subject to the alternative minimum tax.
2Withdrawals prior to age 59½ are subject to a 10% penalty.
_____________________
This article is not intended to provide specific investment advice or recommendations for any individual. Consult your financial advisor, or me, if you have any questions.
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 subscribers’ or others’ use of the content.
Monday, March 19, 2012
Tax Strategies for Retirees
In this world nothing is certain except death and taxes. - Benjamin Franklin
That saying still rings true centuries after the former statesman coined it. Yet, by formulating a tax-efficient investment and distribution strategy, retirees may keep more of their hard-earned assets for themselves and their heirs.
Less Taxing Investments
Municipal bonds, or “munis” have long been appreciated by retirees seeking a haven from taxes and stock market volatility. In general, the interest paid on municipal bonds is exempt from federal taxes and sometimes state and local taxes as well (see table).1 The higher your tax bracket, the more you may benefit from investing in munis.
It is also important to review which types of securities are held in taxable versus tax-deferred accounts. Why? Because at least through the end of 2012, the maximum federal tax rate on some dividend-producing investments and long-term capital gains is 15%. Work with your financial advisor to review your overall investment holdings and determine which investments might be best suited for tax-deferred accounts versus taxable accounts.
The Tax-Exempt Advantage: When Less May Yield More
Would a tax-free bond be a better investment for you than a taxable bond? To find out, compare the yields. For instance, if you were in the 25% federal tax bracket, a taxable bond would need to earn a yield of 6.67% to equal a 5% tax-exempt municipal bond yield.
Federal Tax Rate 15% 25% 28% 33% 35%
Tax-Exempt Rate Taxable-Equivalent Yield
4% 4.71% 5.33% 5.56% 5.97% 6.15%
5% 5.88% 6.67% 6.94% 7.46% 7.69%
6% 7.06% 8% 8.33% 8.96% 9.23%
7% 8.24% 9.33% 9.72% 10.45% 10.77%
8% 9.41% 10.67% 11.11% 11.94% 12.31%
This hypothetical example is used for illustrative purposes only and does not reflect the performance of any specific investment. State, capital gains and alternative minimum taxes are not considered. This formula is only one factor that should be considered when purchasing securities and is meant to be used only as a general guideline when calculating the taxable equivalent yields on Municipal securities.
Which Securities to Tap First?
Another decision facing retirees is when to liquidate various types of assets. The advantage of holding on to tax-deferred investments is that they compound on a before-tax basis and therefore have greater earning potential than their taxable counterparts.
On the other hand, you will need to consider that qualified withdrawals from tax-deferred investments are taxed at ordinary federal income tax rates of up to 35%, while distributions -- in the form of capital gains or dividends -- from investments in taxable accounts are taxed at a maximum of 15%. (Capital gains on investments held for less than one year are taxed at regular income tax rates.) For this reason, it may be beneficial to hold securities in taxable accounts long enough to qualify for the 15% tax rate.
The Ins and Outs of RMDs
The IRS mandates that you begin taking an annual distribution from traditional IRAs and employer-sponsored retirement plans after you reach age 70½. The premise behind the required minimum distribution (RMD) rule is simple: The longer you are expected to live, the less the IRS requires you to withdraw (and pay taxes on) each year.
RMDs are calculated using a Uniform Lifetime Table, which takes into consideration the participant’s life expectancy based on his or her age. Failure to take the RMD can result in a tax penalty equal to 50% of the required amount.
TIP: If you will be pushed into a higher tax bracket at age 70½ due to the RMD rule, it may pay to begin taking withdrawals during your 60s.
Unlike traditional IRAs, Roth IRAs do not require you to take distributions at all during your lifetime and qualified withdrawals are tax free.2 For this reason, you may choose to begin withdrawing assets held in a Roth IRA after you have exhausted other sources of income. Be aware, however, that any named beneficiaries of a Roth IRA will be required to take RMDs following the rules that govern traditional IRAs after your death.
Estate Planning and Gifting
There are various ways to make the tax payments on your assets easier for heirs to handle. Careful selection of beneficiaries is one example. If you do not name a beneficiary, your assets could end up in probate, and your beneficiaries could be taking distributions faster than they expected. In most cases, spousal beneficiaries are ideal because they have several options that are not available to other beneficiaries, including the marital deduction for the federal estate tax.
Also, consider transferring assets into an irrevocable trust if you are close to the threshold for owing estate taxes. In 2012, the federal estate tax applies to all estate assets over $5.12 million, but this threshold is scheduled to revert to $1 million in 2013, unless Congress elects to extend it. Assets in an irrevocable trust are passed on free of estate taxes, saving heirs thousands of dollars.
TIP: If you plan on moving assets from tax-deferred accounts, do so before you reach age 70½, when RMDs must begin.
Finally, if you have a taxable estate, you can give up to $13,000 per individual ($26,000 per married couple) each year to anyone tax free.
Strategies for making the most of your money and reducing taxes are complex. Please meet with an estate attorney and/or a financial advisor to help you sort through your options. For specific tax advice, please see a tax professional.
1. Capital gains from municipal bonds are taxable and may be subject to the alternative minimum tax.
2. Withdrawals prior to age 59½ are subject to a 10% penalty.
This article was not intended to provide specific investment advice or recommendations for any individual. Consult your financial advisor, or me, if you have any questions.
That saying still rings true centuries after the former statesman coined it. Yet, by formulating a tax-efficient investment and distribution strategy, retirees may keep more of their hard-earned assets for themselves and their heirs.
Less Taxing Investments
Municipal bonds, or “munis” have long been appreciated by retirees seeking a haven from taxes and stock market volatility. In general, the interest paid on municipal bonds is exempt from federal taxes and sometimes state and local taxes as well (see table).1 The higher your tax bracket, the more you may benefit from investing in munis.
It is also important to review which types of securities are held in taxable versus tax-deferred accounts. Why? Because at least through the end of 2012, the maximum federal tax rate on some dividend-producing investments and long-term capital gains is 15%. Work with your financial advisor to review your overall investment holdings and determine which investments might be best suited for tax-deferred accounts versus taxable accounts.
The Tax-Exempt Advantage: When Less May Yield More
Would a tax-free bond be a better investment for you than a taxable bond? To find out, compare the yields. For instance, if you were in the 25% federal tax bracket, a taxable bond would need to earn a yield of 6.67% to equal a 5% tax-exempt municipal bond yield.
Federal Tax Rate 15% 25% 28% 33% 35%
Tax-Exempt Rate Taxable-Equivalent Yield
4% 4.71% 5.33% 5.56% 5.97% 6.15%
5% 5.88% 6.67% 6.94% 7.46% 7.69%
6% 7.06% 8% 8.33% 8.96% 9.23%
7% 8.24% 9.33% 9.72% 10.45% 10.77%
8% 9.41% 10.67% 11.11% 11.94% 12.31%
This hypothetical example is used for illustrative purposes only and does not reflect the performance of any specific investment. State, capital gains and alternative minimum taxes are not considered. This formula is only one factor that should be considered when purchasing securities and is meant to be used only as a general guideline when calculating the taxable equivalent yields on Municipal securities.
Which Securities to Tap First?
Another decision facing retirees is when to liquidate various types of assets. The advantage of holding on to tax-deferred investments is that they compound on a before-tax basis and therefore have greater earning potential than their taxable counterparts.
On the other hand, you will need to consider that qualified withdrawals from tax-deferred investments are taxed at ordinary federal income tax rates of up to 35%, while distributions -- in the form of capital gains or dividends -- from investments in taxable accounts are taxed at a maximum of 15%. (Capital gains on investments held for less than one year are taxed at regular income tax rates.) For this reason, it may be beneficial to hold securities in taxable accounts long enough to qualify for the 15% tax rate.
The Ins and Outs of RMDs
The IRS mandates that you begin taking an annual distribution from traditional IRAs and employer-sponsored retirement plans after you reach age 70½. The premise behind the required minimum distribution (RMD) rule is simple: The longer you are expected to live, the less the IRS requires you to withdraw (and pay taxes on) each year.
RMDs are calculated using a Uniform Lifetime Table, which takes into consideration the participant’s life expectancy based on his or her age. Failure to take the RMD can result in a tax penalty equal to 50% of the required amount.
TIP: If you will be pushed into a higher tax bracket at age 70½ due to the RMD rule, it may pay to begin taking withdrawals during your 60s.
Unlike traditional IRAs, Roth IRAs do not require you to take distributions at all during your lifetime and qualified withdrawals are tax free.2 For this reason, you may choose to begin withdrawing assets held in a Roth IRA after you have exhausted other sources of income. Be aware, however, that any named beneficiaries of a Roth IRA will be required to take RMDs following the rules that govern traditional IRAs after your death.
Estate Planning and Gifting
There are various ways to make the tax payments on your assets easier for heirs to handle. Careful selection of beneficiaries is one example. If you do not name a beneficiary, your assets could end up in probate, and your beneficiaries could be taking distributions faster than they expected. In most cases, spousal beneficiaries are ideal because they have several options that are not available to other beneficiaries, including the marital deduction for the federal estate tax.
Also, consider transferring assets into an irrevocable trust if you are close to the threshold for owing estate taxes. In 2012, the federal estate tax applies to all estate assets over $5.12 million, but this threshold is scheduled to revert to $1 million in 2013, unless Congress elects to extend it. Assets in an irrevocable trust are passed on free of estate taxes, saving heirs thousands of dollars.
TIP: If you plan on moving assets from tax-deferred accounts, do so before you reach age 70½, when RMDs must begin.
Finally, if you have a taxable estate, you can give up to $13,000 per individual ($26,000 per married couple) each year to anyone tax free.
Strategies for making the most of your money and reducing taxes are complex. Please meet with an estate attorney and/or a financial advisor to help you sort through your options. For specific tax advice, please see a tax professional.
1. Capital gains from municipal bonds are taxable and may be subject to the alternative minimum tax.
2. Withdrawals prior to age 59½ are subject to a 10% penalty.
This article was not intended to provide specific investment advice or recommendations for any individual. Consult your financial advisor, or me, if you have any questions.
Wednesday, January 25, 2012
Rebalancing to Keep Your Portfolio on Track
Over time some asset classes or investments inevitably outperform or underperform others causing your portfolio allocation to shift. This is especially true during times of heightened volatility, like the markets are experiencing today. This shift, also known as “portfolio drift,” can significantly increase a portfolio’s risk and cause it to become misaligned with its target allocation. To address this problem, you will need to periodically rebalance your portfolio, or adjust the investment mix so that it reflects your target allocation or risk profile.
Many investors dislike rebalancing because it means selling winners in favor of losers. In addition, rebalancing can also generate transaction fees, as well as taxes on gains created by selling securities. Nonetheless, most financial professionals believe the advantages of rebalancing outweigh the disadvantages.
Correcting for Portfolio Drift
To appreciate how performance differences can affect a portfolio over time, throwing it out of sync with its original allocations, consider what happened to a hypothetical portfolio left unbalanced for the 20 years ended December 31, 2010. An original 70% allocation to U.S. stocks would have grown to 81%, while the other allocations would have shrunk, reducing their intended risk reduction role in the portfolio. As always, past performance is no guarantee of future results.
Bonds haven’t been as volatile as stocks over long periods of time, but recent history shows that they too can experience performance patterns that may alter asset allocation over time. Consider the divergence of the stock and bond markets in 2008 and how that affected asset allocations. While the S&P 500 lost 37% during this period, long-term U.S. government bonds gained 23%. A portfolio composed of 50% of each at the start of the year would have shifted to an allocation of 34% stocks and 66% bonds at year’s end.1
Take a Holistic View
If you have multiple investment accounts, determining whether to rebalance may involve several steps, beginning with a check of your overall allocation. This entails figuring how your money is divided among asset classes in each account and then across all accounts, whether in taxable brokerage, mutual fund or tax-deferred accounts.
To gain a full appreciation of your investment strategy, go beyond stocks and bonds and calculate the percentages you have in other asset classes, such as cash and real estate. In addition, you may want to evaluate your allocations to categories within an asset class. In equities, for example, you might consider the percentages in foreign and domestic stocks. For the fixed-income portion of your portfolio, you might break your allocation into U.S. Treasuries, municipals and corporate bonds. If you’re pursuing income from bonds, you may want to know the split among short, medium and long maturities.
How often should you rebalance? The usual answer is anytime your goals change; otherwise, at least once a year. However, to keep close tabs on your investment plan and make sure it doesn’t drift far from your objectives, you may prefer to set a percentage limit of variance, say 5% on either side of your intended target, which would trigger a review and possible rebalancing.
Cost-Effective Rebalancing Strategies
Consider these possibilities for reducing transaction costs and taxable gains when rebalancing:
• Make as many changes as possible in an account that charges low trading fees -- for example, a low-cost brokerage account or a 401(k) account, which may offer free transactions.
• To avoid tax liability, rebalance using new money instead of moving existing money around. Or limit your immediate tax liability by making changes when possible in a tax-deferred account like a 401(k) or an IRA.
• If you’re looking for new money to help rebalance your portfolio, consider using lump-sum payments such as a bonus or tax refund.
This article is not intended to provide specific investment advice or recommendations for any individual. Consult your financial advisor, or me, if you have any questions.
__________________________________
Source: Standard & Poor’s. Performance is for the periods indicated. Stocks are represented by the S&P 500, bonds by long-term U.S Government bonds. Investors cannot invest directly in any index. Past performance does not guarantee future results.
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 subscribers’ or others’ use of the content. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values and yields will decline as interest rates rise and bonds are subject to availability and change in price. Stock investing involves risk including loss of principal.
Many investors dislike rebalancing because it means selling winners in favor of losers. In addition, rebalancing can also generate transaction fees, as well as taxes on gains created by selling securities. Nonetheless, most financial professionals believe the advantages of rebalancing outweigh the disadvantages.
Correcting for Portfolio Drift
To appreciate how performance differences can affect a portfolio over time, throwing it out of sync with its original allocations, consider what happened to a hypothetical portfolio left unbalanced for the 20 years ended December 31, 2010. An original 70% allocation to U.S. stocks would have grown to 81%, while the other allocations would have shrunk, reducing their intended risk reduction role in the portfolio. As always, past performance is no guarantee of future results.
Bonds haven’t been as volatile as stocks over long periods of time, but recent history shows that they too can experience performance patterns that may alter asset allocation over time. Consider the divergence of the stock and bond markets in 2008 and how that affected asset allocations. While the S&P 500 lost 37% during this period, long-term U.S. government bonds gained 23%. A portfolio composed of 50% of each at the start of the year would have shifted to an allocation of 34% stocks and 66% bonds at year’s end.1
Take a Holistic View
If you have multiple investment accounts, determining whether to rebalance may involve several steps, beginning with a check of your overall allocation. This entails figuring how your money is divided among asset classes in each account and then across all accounts, whether in taxable brokerage, mutual fund or tax-deferred accounts.
To gain a full appreciation of your investment strategy, go beyond stocks and bonds and calculate the percentages you have in other asset classes, such as cash and real estate. In addition, you may want to evaluate your allocations to categories within an asset class. In equities, for example, you might consider the percentages in foreign and domestic stocks. For the fixed-income portion of your portfolio, you might break your allocation into U.S. Treasuries, municipals and corporate bonds. If you’re pursuing income from bonds, you may want to know the split among short, medium and long maturities.
How often should you rebalance? The usual answer is anytime your goals change; otherwise, at least once a year. However, to keep close tabs on your investment plan and make sure it doesn’t drift far from your objectives, you may prefer to set a percentage limit of variance, say 5% on either side of your intended target, which would trigger a review and possible rebalancing.
Cost-Effective Rebalancing Strategies
Consider these possibilities for reducing transaction costs and taxable gains when rebalancing:
• Make as many changes as possible in an account that charges low trading fees -- for example, a low-cost brokerage account or a 401(k) account, which may offer free transactions.
• To avoid tax liability, rebalance using new money instead of moving existing money around. Or limit your immediate tax liability by making changes when possible in a tax-deferred account like a 401(k) or an IRA.
• If you’re looking for new money to help rebalance your portfolio, consider using lump-sum payments such as a bonus or tax refund.
This article is not intended to provide specific investment advice or recommendations for any individual. Consult your financial advisor, or me, if you have any questions.
__________________________________
Source: Standard & Poor’s. Performance is for the periods indicated. Stocks are represented by the S&P 500, bonds by long-term U.S Government bonds. Investors cannot invest directly in any index. Past performance does not guarantee future results.
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 subscribers’ or others’ use of the content. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values and yields will decline as interest rates rise and bonds are subject to availability and change in price. Stock investing involves risk including loss of principal.
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