Careers

Take Note of the Distinctive Features of Roth IRAs

For some people, Roth IRAs can offer income and estate tax benefits that are preferable to those offered by traditional IRAs. However, it’s important to take note of just what the distinctive features of a Roth IRA are before making the choice.

Traditional vs. Roth

The biggest difference between traditional and Roth IRAs is how taxes affect contributions and distributions. Contributions to traditional IRAs generally are made with pretax dollars, reducing your current taxable income and lowering your current tax bill. You pay taxes on the funds when you make withdrawals. As a result, if your current tax bracket is higher than what you expect it will be after you retire, a traditional IRA can be advantageous.

In contrast, contributions to Roth IRAs are made with after-tax funds. You pay taxes on the funds now, and your withdrawals won’t be taxed (provided you meet certain requirements). This can be advantageous if you expect to be in a higher tax bracket in retirement or if tax rates increase.

Roth distributions differ from traditional IRA distributions in yet another way. Withdrawals aren’t counted when calculating the taxable portion of your Social Security benefits.

Additional advantages

A Roth IRA may offer a greater opportunity to build up tax-advantaged funds. Your contributions can continue after you reach age 70½ as long as you’re earning income, and the entire balance can remain in the account until your death. In contrast, beginning with the year you reach age 70½, you can’t contribute to a traditional IRA — even if you do have earned income. Further, you must start taking required minimum distributions (RMDs) from a traditional IRA no later than April 1 of the year following the year you reach age 70½.

Avoiding RMDs can be a valuable benefit if you don’t need your IRA funds to live on during retirement. Your Roth IRA can continue to grow tax-free over your lifetime. When your heirs inherit the account, they’ll be required to take distributions — but spread out over their own lifetimes, allowing a continued opportunity for tax-free growth on assets remaining in the account. Further, the distributions they receive from the Roth IRA won’t be subject to income tax.

Many vehicles

As you begin planning for retirement (or reviewing your current plans), it’s important to consider all retirement planning vehicles. A Roth IRA may or may not be one of them. Please contact our firm for individualized help in determining whether it’s a beneficial choice.

Sidebar: TCJA eliminated option to recharacterize Roth IRAs

The passage of the Tax Cuts and Jobs Act late last year had a marked impact on Roth IRAs: to wit, taxpayers who wish to convert a pretax traditional IRA into a post-tax Roth IRA can no longer “recharacterize” (that is, reverse) the conversion for 2018 and later years.

The IRS recently clarified in FAQs on its website that, if you converted a traditional IRA into a Roth account in 2017, you can still reverse the conversion as long as it’s done by October 15, 2018. (This deadline applies regardless of whether you extend the deadline for filing your 2017 federal income tax return to October 15.)

Also, recharacterization is still an option for other types of contributions. For example, you can still make a contribution to a Roth IRA and subsequently recharacterize it as a contribution to a traditional IRA (before the applicable deadline).

 

Assessing Your Exposure to the Estate Tax and Gift Tax

When Congress was debating tax law reform last year, there was talk of repealing the federal estate and gift taxes. As it turned out, rumors of their demise were highly exaggerated. Both still exist and every taxpayer with a high degree of wealth shouldn’t let either take their heirs by surprise.

Exclusions and exemptions

For 2018, the lifetime gift and estate tax exemption is $11.18 million per taxpayer. (The exemption is annually indexed for inflation.) If your estate doesn’t exceed your available exemption at your death, no federal estate tax will be due.

Any gift tax exemption you use during life does reduce the amount of estate tax exemption available at your death. But not every gift you make will use up part of your lifetime exemption. For example:

• Gifts to your U.S. citizen spouse are tax-free under the marital deduction, as are transfers at death (bequests).
• Gifts and bequests to qualified charities aren’t subject to gift and estate taxes.
• Payments of another person’s health care or tuition expenses aren’t subject to gift tax if paid directly to the provider.
• Each year you can make gifts up to the annual exclusion amount ($15,000 per recipient for 2018) tax-free without using up any of your lifetime exemption.

It’s important to be aware of these exceptions as you pass along wealth to your loved ones.

A simple projection

Here’s a simplified way to help project your estate tax exposure. Take the value of your estate, net of any debts. Also subtract any assets that will pass to charity on your death.

Then, if you’re married and your spouse is a U.S. citizen, subtract any assets you’ll pass to him or her. (But keep in mind that there could be estate tax exposure on your surviving spouse’s death, depending on the size of his or her estate.) The net number represents your taxable estate.

You can then apply the exemption amount you expect to have available at death. Remember, any gift tax exemption amount you use during your life must be subtracted. But if your spouse predeceases you, then his or her unused estate tax exemption, if any, may be added to yours (provided the applicable requirements are met).

If your taxable estate is equal to or less than your available estate tax exemption, no federal estate tax will be due at your death. But if your taxable estate exceeds this amount, the excess will be subject to federal estate tax.

Be aware that many states impose estate tax at a lower threshold than the federal government does. So, you could have state estate tax exposure even if you don’t need to worry about federal estate tax.

Strategies to consider

If you’re not sure whether you’re at risk for the estate tax, or if you’d like to learn about gift and estate planning strategies to reduce your potential liability, please contact us.

TCJA Draws a Silver Lining Around the Individual AMT

The Tax Cuts and Jobs Act (TCJA) didn’t eliminate the individual alternative minimum tax (AMT). But the law did draw a silver lining around it. Revised rules now lessen the likelihood that many taxpayers will owe substantial taxes under the AMT for 2018 through 2025.

Parallel universe

Think of the AMT as a parallel universe to the regular federal income tax system. The difference: The AMT system taxes certain types of income that are tax-free under the regular tax system and disallows some regular tax deductions and credits.

The maximum AMT rate is 28%. By comparison, the maximum regular tax rate for individuals has been reduced to 37% for 2018 through 2025 thanks to the TCJA. For 2018, that 28% AMT rate starts when AMT income exceeds $191,100 for married joint-filing couples and $95,550 for others (as adjusted by Revenue Procedure 2018-18).

Exemption available

Under the AMT rules, you’re allowed a relatively large inflation-adjusted AMT exemption. This amount is deducted when calculating your AMT income. The TCJA significantly increases the exemption for 2018 through 2025. The exemption is phased out when your AMT income surpasses the applicable threshold, but the TCJA greatly increases those thresholds for 2018 through 2025.

If your AMT bill for the year exceeds your regular tax bill, you must pay the higher AMT amount. Originally, the AMT was enacted to ensure that very wealthy people didn’t avoid paying tax by taking advantage of “too many” tax breaks. Unfortunately, the AMT also hit some unintended targets. The new AMT rules are better aligned with Congress’s original intent.

Under both old and new law, the exemption is reduced by 25% of the excess of AMT income over the applicable exemption amount. But under the TCJA, only those with high incomes will see their exemptions phased out, while others — particularly middle-income taxpayers — will benefit from full exemptions.

Need to plan

For many taxpayers, the AMT rules are less worrisome than they used to be. Let our firm assess your liability and help you plan accordingly.

Sidebar: High-income earners back in the AMT spotlight

Before the Tax Cuts and Jobs Act (TCJA), many high-income taxpayers weren’t affected by the alternative minimum tax (AMT). That’s because, after multiple legislative changes, many of their tax breaks were already cut back or eliminated under the regular income tax rules. So, there was no need to address the AMT.

If one’s income exceeds certain levels, phaseout rules chip away or eliminate other tax breaks. As a result, higher-income taxpayers had little or nothing left to lose by the time they got to the AMT calculation, while many upper-middle-income folks still had plenty left to lose. Also, the highest earners were in the 39.6% regular federal income tax bracket under prior law, which made it less likely that the AMT — with its maximum 28% rate — would hit them.

In addition, the AMT exemption is phased out as income goes up. This amount is deducted in calculating AMT income. Under previous law, this exemption had little or no impact on individuals in the top bracket because the exemption was completely phased out. But the exemption phaseout rule made upper-middle-income taxpayers more likely to owe AMT under previous law. Suffice it to say that, under the TCJA, high-income earners are back in the AMT spotlight. So, proper planning is essential.

 

Study Up on the Tax Advantages of a 529 Savings Plan

With kids back in school, it’s a good time for parents (and grandparents) to think about college funding. One option, which can be especially beneficial if the children in question still have many years until heading off to college, is a Section 529 plan.

Tax-deferred compounding

529 plans are generally state-sponsored, and the savings-plan option offers the opportunity to potentially build up a significant college nest egg because of tax-deferred compounding. So, these plans can be particularly powerful if contributions begin when the child is young. Although contributions aren’t deductible for federal purposes, plan assets can grow tax-deferred. In addition, some states offer applicable state tax incentives.

Distributions used to pay qualified expenses (such as tuition, mandatory fees, books, supplies, computer-related items and, generally, room and board) are income-tax-free for federal purposes and, in many cases, for state purposes as well. (The Tax Cuts and Jobs Act changes the definition of “qualifying expenses” to include not just postsecondary school costs, but also primary and secondary school expenses.)

Additional benefits

529 plans offer other benefits, too. They usually have high contribution limits and no income-based phaseouts to limit contributions. There’s generally no beneficiary age limit for contributions or distributions. And the owner can control the account — even after the child is a legal adult — as well as make tax-free rollovers to another qualifying family member.

Finally, 529 plans provide estate planning benefits: A special break for 529 plans allows you to front-load five years’ worth of annual gift tax exclusions, which means you can make up to a $75,000 contribution (or $150,000 if you split the gift with your spouse) in 2018. In the case of grandparents, this also can avoid generation-skipping transfer taxes.

Minimal minuses

One negative of a 529 plan is that your investment options are limited. Another is that you can make changes to your options only twice a year or if you change the beneficiary.

But whenever you make a new contribution, you can choose a different option for that contribution, no matter how many times you contribute during the year. Also, you can make a tax-free rollover to another 529 plan for the same child every 12 months.

More to learn

We’ve focused on 529 savings plans here; a prepaid tuition version of 529 plans is also available. If you’d like to learn more about either type of 529 plan, please contact us.

Are You a Member of the Sandwich Generation?

If you’re currently taking care of your children and elderly parents, count yourself among those in the “Sandwich Generation.” Although it may be personally gratifying to help your parents, it can be a financial burden and affect your own estate plan. Here are some critical steps to take to better manage the situation.

Identify key contacts

Just like you’ve done for yourself, compile the names and addresses of professionals important to your parents’ finances and medical conditions. These may include stockbrokers, financial advisors, attorneys, CPAs, insurance agents and physicians.

List and value their assets

If you’re going to be able to manage the financial affairs of your parents, having knowledge of their assets is vital. Keep a list of their investment holdings, IRA and retirement plan accounts, and life insurance policies, including current balances and account numbers. Be sure to add in projections for Social Security benefits.

Open the lines of communication

Before going any further, have a frank and honest discussion with your elderly relatives, as well as other family members who may be involved, such as your siblings. Make sure you understand your parents’ wishes and explain the objectives you hope to accomplish. Understandably, they may be hesitant or too proud to accept your help initially.

Execute the proper documents

Assuming you can agree on how to move forward, develop a plan incorporating several legal documents. If your parents have already created one or more of these documents, they may need to be revised or coordinated with new ones. Some elements commonly included in an estate plan are:

Wills. Your parents’ wills control the disposition of their possessions, such as cars, and tie up other loose ends. (Of course, jointly owned property with rights of survivorship automatically pass to the survivor.) Notably, a will also establishes the executor of your parents’ estates. If you’re the one providing financial assistance, you may be the optimal choice.

Living trusts. A living trust can supplement a will by providing for the disposition of selected assets. Unlike a will, a living trust doesn’t have to go through probate, so this might save time and money, while avoiding public disclosure.

Powers of attorney for health and finances. These documents authorize someone to legally act on behalf of another person. With a durable power of attorney, the most common version, the authorization continues after the person is disabled. This enables you to better handle your parents’ affairs.

Living wills or advance medical directives. These documents provide guidance for end-of-life decisions. Make sure that your parents’ physicians have copies, so they can act according to their wishes.

Beneficiary designations. Undoubtedly, your parents have completed beneficiary designations for retirement plans, IRAs and life insurance policies. These designations supersede references in a will, so it’s important to keep them up to date.

Spread the wealth

If you decide the best approach for helping your parents is to give them monetary gifts, it’s relatively easy to avoid gift tax liability. Under the annual gift tax exclusion, you can give each recipient up to $15,000 (for 2018) without paying any gift tax. Plus, payments to medical providers aren’t considered gifts, so you may make such payments on your parents’ behalf without using any of your annual exclusion or lifetime exemption amount.

Mind your needs

If you’re part of the Sandwich Generation, you already have a lot on your plate. But don’t overlook your own financial needs. Contact us to discuss the matter further.

 

Fourth Quarter Tax Calendar

October 15 — Personal federal income tax returns that received an automatic six-month extension must be filed today and any tax, interest and penalties due must be paid.

• The Financial Crimes Enforcement Network (FinCEN) Report 114, “Report of Foreign Bank and Financial Accounts” (FBAR), must be filed by today, if not filed already, for offshore bank account reporting. (This report received an automatic extension to today if not filed by the original due date of April 17.)
• If a six-month extension was obtained, calendar-year C corporations should file their 2017 Form 1120 by this date.
• If the monthly deposit rule applies, employers must deposit the tax for payments in September for Social Security, Medicare, withheld income tax and nonpayroll withholding.

October 31 — The third quarter Form 941 (“Employer’s Quarterly Federal Tax Return”) is due today and any undeposited tax must be deposited. (If your tax liability is less than $2,500, you can pay it in full with a timely filed return.) If you deposited the tax for the quarter in full and on time, you have until November 13 to file the return.

• If you have employees, a federal unemployment tax (FUTA) deposit is due if the FUTA liability through September exceeds $500.

November 15 — If the monthly deposit rule applies, employers must deposit the tax for payments in October for Social Security, Medicare, withheld income tax, and nonpayroll withholding.

December 17 — Calendar-year corporations must deposit the fourth installment of estimated income tax for 2018.

• If the monthly deposit rule applies, employers must deposit the tax for payments in November for Social Security, Medicare, withheld income tax, and nonpayroll withholding.

Taxable vs. Tax-advantaged: Where to Hold Investments

When investing for retirement or other long-term goals, people usually prefer tax-advantaged accounts, such as IRAs, 401(k)s or 403(b)s. Certain assets are well suited to these accounts, but it may make more sense to hold other investments in traditional taxable accounts.

Know the rules

Some investments, such as fast-growing stocks, can generate substantial capital gains, which may occur when you sell a security for more than you paid for it.

If you’ve owned that position for over a year, you face long-term gains, taxed at a maximum rate of 20%. In contrast, short-term gains, assessed on holding periods of a year or less, are taxed at your ordinary-income tax rate — maxing out at 37%. (Note: These rates don’t account for the possibility of the 3.8% net investment income tax.)

Choose tax efficiency

Generally, the more tax efficient an investment, the more benefit you’ll get from owning it in a taxable account. Conversely, investments that lack tax efficiency normally are best suited to tax-advantaged vehicles.

Consider municipal bonds (“munis”), either held individually or through mutual funds. Munis are attractive to tax-sensitive investors because their income is exempt from federal income taxes and sometimes state and local income taxes. Because you don’t get a double benefit when you own an already tax-advantaged security in a tax-advantaged account, holding munis in your 401(k) or IRA would result in a lost opportunity.

Similarly, tax-efficient investments such as passively managed index mutual funds or exchange-traded funds, or long-term stock holdings, are generally appropriate for taxable accounts. These securities are more likely to generate long-term capital gains, which have more favorable tax treatment. Securities that generate more of their total return via capital appreciation or that pay qualified dividends are also better taxable account options.

Take advantage of income

What investments work best for tax-advantaged accounts? Taxable investments that tend to produce much of their return in income. This category includes corporate bonds, especially high-yield bonds, as well as real estate investment trusts (REITs), which are required to pass through most of their earnings as shareholder income. Most REIT dividends are nonqualified and therefore taxed at your ordinary-income rate.

Another tax-advantaged-appropriate investment may be an actively managed mutual fund. Funds with significant turnover — meaning their portfolio managers are actively buying and selling securities — have increased potential to generate short-term gains that ultimately get passed through to you. Because short-term gains are taxed at a higher rate than long-term gains, these funds would be less desirable in a taxable account.

Get specific advice

The above concepts are only general suggestions. Please contact our firm for specific advice on what may be best for you.

Sidebar: Doing due diligence on dividends

If you own a lot of income-generating investments, you’ll need to pay attention to the tax rules for dividends, which belong to one of two categories:

1. Qualified. These dividends are paid by U.S. corporations or qualified foreign corporations. Qualified dividends are, like long-term gains, subject to a maximum tax rate of 20%, though many people are eligible for a 15% rate. (Note: These rates don’t account for the possibility of the 3.8% net investment income tax.)

2. Nonqualified. These dividends — which include most distributions from real estate investment trusts and master limited partnerships — receive a less favorable tax treatment. Like short-term gains, nonqualified dividends are taxed at your ordinary-income tax rate.

 

Is Now the Time for Some Life Insurance?

Many people reach a point in life when buying some life insurance is highly advisable. Once you determine that you need it, the next step is calculating how much you should get and what kind.

Careful calculations

If the coverage is to replace income and support your family, this starts with tallying the costs that would need to be covered, such as housing and transportation, child care, and education — and for how long. For many families, this will be only until the youngest children are on their own.

Next, identify income available to your family from Social Security, investments, retirement savings and any other sources. Insurance can help bridge any gaps between the expenses to be covered and the income available.

If you’re purchasing life insurance for another reason, the purpose will dictate how much you need:

Funeral costs. An average funeral bill can top $7,000. Gravesite costs typically add thousands more to this number.

Mortgage payoff. You may need coverage equal to the amount of your outstanding mortgage balance.

Estate planning. If the goal is to pay estate taxes, you’ll need to estimate your estate tax liability. If it’s to equalize inheritances, you’ll need to estimate the value of business interests going to each child active in your business and purchase enough coverage to provide equal inheritances to the inactive children.

Term vs. permanent

The next question is what type of policy to purchase. Life insurance policies generally fall into two broad categories: term or permanent.

Term insurance is for a specific period. If you die during the policy’s term, it pays out to the beneficiaries you’ve named. If you don’t die during the term, it doesn’t pay out. It’s typically much less expensive than permanent life insurance, at least if purchased while you’re relatively young and healthy.

Permanent life insurance policies last until you die, so long as you’ve paid the premiums. Most permanent policies build up a cash value that you may be able to borrow against. Over time, the cash value also may reduce the premiums.

Because the premiums are typically higher for permanent insurance, you need to consider whether the extra cost is worth the benefits. It might not be if, for example, you may not require much life insurance after your children are grown.

But permanent life insurance may make sense if you’re concerned that you could become uninsurable, if you’re providing for special-needs children who will never be self-sufficient, or if the coverage is to pay estate taxes or equalize inheritances.

Some comfort

No one likes to think about leaving loved ones behind. But you’ll no doubt find some comfort in having a life insurance policy that helps cover your family’s financial needs and plays an important role in your estate plan. Let us help you work out the details.