Year-End Retirement Planning

qtq80-zQuhyX-1024x666 Year-End Retirement Planning

A major feature of the TCJA is the reduction of income tax rates owed by individuals. For example, married couples filing jointly for 2018 may have taxable income up to $77,400 and remain in the 12% bracket, up to $165,000 and stay in the 22% bracket, and up to $315,000 and stay in the 24% bracket. For single filers, the taxable income numbers are exactly 50% of those in the last sentence. Keep in mind that the numbers are for taxable income after all deductions have been taken.

In terms of retirement planning at year-end, one result is that low tax rates make tax deferral less attractive. Boosting your 401(k) contributions now may have less of a payoff than in previous years.

On the other hand, withdrawing from tax-deferred retirement accounts has become less difficult. That includes converting pre-tax dollars from a traditional, SEP, or SIMPLE IRA to a Roth IRA for potential tax-free distributions after five years, if you are at least age 59½.

No Looking Back

Roth IRA conversions have a catch, though. You no longer can reverse (recharacterize) a Roth IRA conversion back to a pre-tax IRA.

Example 1: Suppose Stephanie Jackson converts a $100,000 traditional IRA to a Roth IRA in November 2018. No matter what happens to that Roth IRA’s value in the interim, Stephanie will report $100,000 of taxable income on her 2018 tax return.

Therefore, the end of a calendar year can be the best time for a Roth IRA conversion. By then, you may have a good idea of your taxable income for the year, so you can make a tax-efficient partial conversion.

Example 2: Stephanie and her husband Tom calculate that they will have about $110,000 in taxable income on their joint return for 2018. Thus, one or both Jacksons could convert up to $55,000 and stay in the 22% tax bracket. Instead, they choose to have Stephanie convert $40,000 in late 2018. That will add $8,800 to their 2018 federal income tax bill (22% of $40,000), an amount they can comfortably pay from their cash reserves.

Planning Ahead

An alternate approach is to set aside an amount to convert from a traditional to a Roth IRA each year.

Example 3: Chet and Doris Carson report from $200,000 to $250,000 of taxable income each year, placing them squarely in the 24% tax bracket. Between them, they have $600,000 in traditional IRAs. The Carsons plan to convert $60,000 to a Roth IRA every year, generating a $14,400 annual federal income tax obligation. After 10 years, their traditional IRAs will be mostly or fully depleted, so the Carsons will owe little in the way of RMDs after age 70½. Roth IRA owners never have RMDs.

Roth IRA distributions are completely tax-free once the age 59½ and the five-year hurdles are cleared. Any Roth IRA conversion in 2018, no matter how late in the year, has a start date of January 1, 2018, so the five-year requirement after a year-end conversion will be met in just over four years.

Double Trouble

Tax-deferred retirement accounts generally have RMDs after age 70½. Therefore, taxpayers in this age group should be sure to meet their annual requirement by year-end. Any shortfall can trigger a 50% penalty.

In addition, each spouse must withdraw the RMD from his or her own account to avoid the penalty.

Example 4: Robert and Jan King each have a $20,000 RMD for 2018. Suppose Robert withdraws $40,000 from his IRA in 2018, but Jan does not take anything from her IRA.

In this situation, the IRS has collected the amount owed by the Kings. That makes no difference. Jan will still face a $10,000 penalty: 50% of her $20,000 RMD shortfall.

Do you have questions?

With all the tax changes happening this year, it might make sense to contact us for help.

Funding Company’s Buy-Sell With Life Insurance Can Be Tricky

life-insurance-buy-sell_LI-532x266 Funding Company’s Buy-Sell With Life Insurance Can Be Tricky
Photo: Stock

Among the trigger events of a small company buy-sell agreement, death of a co-owner typically is included.

Example 1: Wendy Young and Victor Thomas both own 50% of YT Corp. They have a buy-sell, which calls for Wendy to buy Victor’s interest in YT if he dies. Similarly, Victor will buy Wendy’s interest in YT from her estate if she is the first to die.

Small company buy-sells such as the one for YT Corp. often fall into one of two categories:

  • Cross purchase. Wendy will buy Victor’s shares directly from his heirs, or vice versa.
  • Here, YT Corp. will buy the decedent’s interest. If Victor is first to die, YT will buy his shares, leaving Wendy as the sole owner.

Finding the Funds 

With either type of buy-sell, a “buy” must be made, and the decedent’s interest in the company might be extremely valuable. Therefore, life insurance often is used to provide the funds for the buyout.

Example 2: In a cross-purchase arrangement, Wendy will acquire a policy on Victor’s life, and Victor will own a policy on Wendy’s life. If Victor dies, the insurance payout will go to Wendy, generally free of income tax. Wendy can use this money to buy Victor’s interest in YT Corp. from his estate at the price set in the buy-sell.

If Victor is the survivor, the process will take place in reverse.

Pros and Cons

There are some advantages to a cross-purchase arrangement. If the shares have appreciated over the years, Wendy will get a basis step-up to current value when she buys Victor’s shares. That could reduce the tax on a future sale of all of Wendy’s shares.

On the other hand, the premiums on a large life insurance policy could be substantial. Wendy and Victor might not be willing and able to pay these costs personally. This issue could be further complicated if, say, Victor is much older than Wendy and in poor health. The premiums on a policy insuring Victor could be much higher than the premiums for a policy insuring Wendy; this disparity may have to be resolved by some financial arrangement between the owners.

In addition, not every small company has 2 co-owners. With 3 owners, each would have to own life insurance policies on 2 others, for a total of 6 policies. Four owners would need 12 policies, and so on.

Regarding Redemptions 

Some of these cross-purchase problems can be resolved by using a corporate redemption plan.

Example 3: In a redemption plan, YT Corp. needs to buy only two life insurance policies: one on Wendy and the other on Victor. If Victor dies, the death benefit goes to YT, which uses the money to redeem Victor’s shares. If Wendy dies first, YT will buy her shares.

This method addresses the problems of multiple owners, uneven premium payments, and personal outlays for premiums. On the negative side, a redemption plan places what might be valuable insurance policies in the company’s possession, subject to creditors’ claims. Adverse tax issues also may arise, including the loss of a basis step-up for the surviving co-owner or owners.

Other ways to use life insurance for buy-sells may be suggested by an experienced insurance agent. For instance, a trust might be created and funded by multiple co-owners, with an independent trustee acquiring life insurance policies on those owners’ lives. The taxation of a trusteed buy-sell might be more favorable than taxation of a redemption plan. Our office can explain the likely tax consequences of any strategy you’re considering for funding a buy-sell through life insurance.

If your company initiates a buy-sell to be funded with life insurance, make sure to keep the policies up to date. If the company’s value grows but the coverage doesn’t increase, the insurance payout could be only a fraction of the required purchase price.

 

 

Disclaimer: This post originally appeared in the CPA Client Bulletin Resource Guide, © 2018 Association of International Certified Professional Accountants. Reprinted by permission.

Life Insurance for More Than Just Cash Flow

life-insurance_LI-532x266 Life Insurance for More Than Just Cash Flow
Photo: Stock

 

Many people think of life insurance as a product for family protection. The life of one or two breadwinners is insured; in case of an untimely death, the insurance payout can help with raising children and maintaining the current lifestyle.

Once the children are able to live independently and a surviving spouse is financially secure, insurance coverage may be dropped. Such a strategy uses life insurance as a hedge against the risk of lost income when that cash flow is vital.

This type of planning is often necessary. That said, life insurance may serve other purposes, including some that are not readily apparent.

Final Expenses

When someone dies, funeral and burial expenses can be daunting. In addition, the decedent’s debts might need to be paid off, perhaps including substantial end-of-life medical bills. Many insurers offer policies specifically for these and other post-death obligations, with death benefits commonly ranging from $10,000 to $50,000.

The beneficiary, typically a surviving spouse or child, can receive a cash inflow in a relatively short time. Generally, this payout won’t be subject to income tax. The result might be less stress for beneficiaries during a difficult time and a reduced need to make immediate financial decisions in order to raise funds.

Investment Support

This year’s stock market volatility has worried some investors, who may be tempted to turn to safer holdings, which have little or no long-term growth potential. Prudent use of life insurance might help to allay such fears.

Example 1: Jill Miller has $600,000 in her investment portfolio, where she has a sizable allocation to stocks. She is concerned that an economic downturn could drop her portfolio value to $500,000, $400,000, or less. Therefore, Jill buys a $250,000 policy on her life.

Now Jill knows that her children, the policy beneficiaries, will receive that $250,000 at her death, income-tax-free, in addition to any other assets she’ll pass down. This gives her the confidence to continue holding stocks, which might deliver substantial gains for Jill and her children.

Balancing Acts

Life insurance also can help to treat heirs equally, if that is someone’s intention, but circumstances create challenges.

Example 2: Charles Phillips, a widower, owns a successful business in which his older daughter Diane has become a key executive. Charles would like to leave the company to Diane, but that would exclude his younger daughter Eve, who has other interests.

Therefore, Charles buys a large insurance policy on his life, payable to Eve. This assured death benefit for Eve will help Charles structure his estate plan so that both of his daughters will be treated fairly. There is a potential downside to consider if Charles is wealthy enough to have an estate that is subject to the federal estate tax ($11.18 million in 2018). In this case, a large insurance policy will swell his gross estate, leading to a greater estate tax liability.

Life insurance may be especially helpful when one or both spouses has children from a previous marriage.

Example 3: Jim Devlin’s estate plan calls for most of his assets to be left in trust for his second wife, Robin. At Robin’s death, the trust assets will pass to Jim’s children from his first marriage. Robin is younger than Jim, so it could be many years before his children receive a meaningful inheritance.

Again, life insurance can provide an answer. If Jim insures his life and names his children as beneficiaries, his children may get an ample amount without having a long wait.

Proceed Carefully

The life insurance marketplace ranges from straightforward term policies to so-called permanent policies (forms of variable, universal, or whole life) that have investment accounts with cash value. In some cases, policyholders can tap the cash value for tax-free funds while they’re alive.

Our team can help explain the tax aspects of a policy you’re considering, but you should exercise caution when evaluating any possible purchase of life insurance. Give us a call to find out what you’ll be paying and what you’ll be receiving in return.

Additional Resources

Disclaimer: This post originally appeared in the CPA Client Bulletin Resource Guide, © 2018 Association of International Certified Professional Accountants. Reprinted by permission.

More Give in the Gift Tax

girl-balloons_LI-532x266 More Give in the Gift Tax
Photo: Senjuti Kundu

The Tax Cuts and Jobs Act of 2017 increased the federal estate tax exemption to $11.18 million for 2018. That’s per person, so the combined exemption for a married couple can be as much as $22,360,000 worth of assets this year.

The same ceilings apply to the federal gift tax, which offsets the estate tax.

Example 1: Mona McAfee plans to give $20,000 to her son Luke this year. Does that mean that Mona’s estate tax exemption would be reduced to $11,160,000?

Probably not. In addition to the lifetime exemption numbers now in effect, there is also an annual gift tax exclusion. Due to an ongoing process of inflation adjustment, that exemption increased to $15,000 in 2018. Therefore, in 2018, each person can give up to $15,000 to any number of recipients without incurring gift tax consequences. That’s up from an annual $14,000 exclusion, which was in effect the previous five years.

Here, Mona’s $20,000 would be partially covered by the $15,000 exclusion, so only $5,000 will have gift tax consequences. Mona would have to report a $5,000 taxable gift on IRS Form 709. That $5,000 taxable gift will reduce her current federal estate and gift tax exemption amount to $11,175,000, assuming no other taxable gifts have been made.

As the recipient of the gift, Luke will pay no taxes.

Real-World Relevance

Most people won’t have estates close to $11 million, so this exercise might seem academic. Still, the $15,000 annual gift tax exclusion can have practical effects in many situations. It’s also worth noting that paying someone else’s medical or education bills directly won’t be included in the $15,000 allowance.

Example 2: Rhonda Cole wants to provide financial support for her son Mark’s two children, Ken and Julie. To do so, Rhonda pays tuition bills for Ken and Julie directly to their colleges. The total is $50,000. In addition, Rhonda gives them each $15,000 in 2018 and no other gifts.

Rhonda also decides to give Mark $15,000 this year and pays $5,000 worth of bills from Mark’s medical procedures directly to the health care providers. In total, Rhonda has given $100,000 to her loved ones, reducing her taxable estate by that amount. However, she hasn’t gone over the $15,000 exclusion for any recipient in 2018, so Rhonda hasn’t made any taxable gifts and will not have to file a gift tax return.

Note that the $15,000 limit presents a handy ceiling for making family gifts each year without the bother and expense of filing a gift tax return. This strategy won’t work as well if Rhonda gives Mark $50,000 so Mark can pay his children’s college bills. Then, Rhonda will have made a taxable gift of this amount and will be required to file Form 709.

Paired Planning

Other possibilities exist if a married couple holds assets jointly, perhaps in a bank or brokerage account. A gift from such an account, or a gift of other property, by one spouse can be considered to be divided equally between the two spouses, so the annual gift tax allowance effectively increases to $30,000. There are two ways to do this. The easy way would be for each spouse to write a separate check for $15,000. If this is not practical, the spouses can get the benefit of a $30,000 annual exclusion by electing “gift splitting” on Form 709.

Gift tax Notes

  • The gift tax lifetime exemption ceiling of $11.18 million for 2018 will increase with inflation, but much lower limits are scheduled after 2025. There is some uncertainty about how this reduction, if it takes effect as scheduled, will affect large taxable gifts.
  • Any future reduction in the lifetime gift tax exemption is unlikely to affect gifts that conform to annual gift tax exclusion rules.

If you have any questions about how gift tax works, please contact our office. One of our tax professionals would be glad to help. You can also complete the following form and we can contact you.

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1908909672 More Give in the Gift Tax



This post originally appeared in the CPA Client Bulletin Resource Guide, © 2018 Association of International Certified Professional Accountants. Reprinted by permission.

A Bucket Plan Helps Reduce Market Impact on Retirement Funds

travel-the-world_LI A Bucket Plan Helps Reduce Market Impact on Retirement Funds
Photo: Priscilla Du Preez

We have seen an increase in market volatility in early 2018. A steep pullback in stocks could be good news for working people who are building retirement funds, but those approaching or recently beginning retirement might be hurt.

Historically, stock market setbacks have proven to be buying opportunities for patient investors.

Example 1: Harry Walker was 50 years old in 2008, with most of his retirement savings invested in stock funds within his 401(k) account. Then, Harry’s holdings dropped heavily.

Harry stayed the course and continued to buy stock funds as the Dow Jones Industrial Average (DJIA) rebounded from a 2008 low around 7,500 to 10,000 in 2009, 11,000 in 2010, and so on. Therefore, Harry has built substantial wealth, with the DJIA around 24,000 as of this writing.

Vulnerable to Volatility

Ten years later, Harry’s situation is different.

Example 2: Harry is age 60 now, with $1 million in his 401(k). He plans to retire at 62, but a stock market collapse could trigger a 40% drop, reducing his $1 million 401(k) to $600,000. Harry might have to postpone his retirement or reduce the amount he withdraws from a smaller portfolio. If Harry stops working, he may not be able to keep investing and profit again from any market rebound.

Harry could avoid this potential problem by moving his 401(k) account from stock funds into cash. However, yields on bank accounts and the like are extremely low. If Harry moves out of stocks at age 60, he’ll avoid market risk but also reduce his opportunity for substantial investment growth going forward.

Going for the Flow 

Instead of moving 100% to cash, Harry could implement a so-called “bucket plan.” These plans vary, but the key to success is to have a substantial cash bucket. Continuing our example, Harry Walker would figure out how much money he’ll need for living expenses each month from his portfolio after he stops working. Typically, a cash bucket will hold at least a year’s worth of cash flow.

Example 3: Harry calculates that he’ll need $4,000 a month from his 401(k) or from an IRA after a rollover to maintain a desired lifestyle. If Harry needs to take $4,000 a month from his retirement plan, he would hold at least $48,000 in his cash bucket at the start of retirement with this strategy. From the cash bucket, Harry would arrange to have $4,000 paid into his checking account each month, just as his paychecks from work were handled.

Regular Refills

Setting up the cash bucket is just the beginning of a bucket plan. That bucket must be replenished so cash can keep flowing.

One way to do this is to divide portfolio assets into two broad categories: fixed income (mainly bonds) and equities (mainly stocks). At regular intervals, money can flow from the fixed income bucket into the cash bucket and from the equities bucket into the fixed income bucket. This allows stocks to be held for the long term, which, historically, has been a winning investment strategy.

Other bucket plan strategies can be used. If this method appeals to you as a way to address possible market volatility, our team can go over your plan to illustrate how various portfolio assets can be delivered to you as after-tax cash flow.

Additional Retirement Resources

This post originally appeared in the CPA Client Bulletin Resource Guide, © 2018 Association of International Certified Professional Accountants. Reprinted by permission.