What is perfect tax planning when it comes to tax returns?

Michael Hoeflinger, CFP®
Wealth Manager

It’s that time of year again when millions of Americans file their tax returns before the deadline, hoping for a tax refund of some sort. But is that really the best strategy from a financial planning standpoint? The best tax planning is to have a tax balance of zero when it’s time to file, which means you would neither owe anything nor receive a refund. This would indicate that you paid exactly the amount of tax liability owed for that particular year.

This tax season will be different for filers under the Tax Cuts and Jobs Act that went into effect in 2018. Some of the major changes from the new law include a higher standard deduction ($12,000 for single filers and $24,000 for married persons filing jointly), the elimination of personal exemptions, new limits placed on itemized deductions and a new $10,000 cap on state and local deductions. The law also changed the higher standard deduction for the elderly, the blind and those with a disability. Furthermore, the IRS and Treasury department released new withholding tables, which means that the guidelines your employer follows in order to deduct the appropriate amount of income tax from your paycheck have changed.

  2017 2018-2025
Standard Deductions    
Single $6,350 $12,000
Married filing jointly $12,700 $24,000
Elderly or blind

(single and not a surviving spouse)

Add’l $1,550 Add’l $1,600
Elderly

(both over age 65 and married filing jointly

Add’l $2,500 Add’l $2,600
Exemption    
Personal exemption $4,050 per family member Eliminated

What can you do if you are surprised after filing your 2018 tax return? First, take a look at your tax withholding from your employer and think about what you can do to adjust it. This could be as simple as reviewing your W-4 form with your employer alongside the withholding tables to help best determine your income tax load. For example, if you claim too many allowances on your W-4, your employer will withhold less tax from your paycheck, but you may owe the following year. If you claim zero allowances, you may overpay and get a refund come tax time, but you will take home less pay per month as a result of the taxes. If you need less of your income to be taxed, make sure you are contributing more to your employer’s retirement plan as well as any other tax-sheltered accounts (assuming you are not already at the maximum allowed). If you are a 1099 employee, you may need to evaluate how much you are paying in taxes each quarter to make sure you get the liability just right.

Tax planning is a critical component of your overall financial planning, and making the necessary adjustments along the way will help you over both the short and long term.

Feel free to contact Michael Hoeflinger with any questions by phone 305.448.8882 ext. 241 or email: MHoeflinger@Evensky.com

REFERENCE: www.irs.gov

For more information on financial planning visit our website at www.Evensky.com

My Own “Jiminy Cricket”

Brett Horowitz

Brett Horowitz, CFP®, AIF® Principal, Wealth Manager

Whether you are working with a doctor, lawyer, or financial professional, you need to be aware of who is watching over you. It’s not enough to simply assume that they are on your side. When someone gives us recommendations, we want them to be like the Jiminy Cricket character in Pinocchio—a trustworthy person who is looking out for us and helping us make good decisions. Let’s look at an example to help frame this discussion.

You go to the doctor’s office complaining of muscle pain, and the doctor offers you a choice of medications. He hands you Medicine A and you walk out the door, feeling comfortable that he gave you the right medication that will make you feel better in no time. Why are you so at ease with the doctor’s recommendations? The short answer is that you trust the doctor. You believe that they will follow the Hippocratic Oath, which says in summary “above all, do no harm.” You have come to expect that they are providing you with advice that is in your, the patient’s, best interest. What if I told you that the financial profession doesn’t work that way? Surprised? Confused? If you’re like most Americans, you’re not alone.

According to a recent study by the RAND Corporation, commissioned by the SEC, most Americans have trouble distinguishing between advisors and brokers. As the study’s authors note, “Our analysis confirmed findings from previous studies and from our interviews with stakeholders: Investors had difficulty distinguishing among industry professionals and perceiving the web of relationships among service providers.” When a financial professional can have dozens of different titles, ranging from investment advisor to wealth manager to financial planner, it’s not hard to see why consumers are confused. One of the major differences comes down to a popular buzzword in the industry that every investor should understand: the term FIDUCIARY.

What is a fiduciary?

Quite frankly, one of the first questions you should ask your investment professional is this: Are you a fiduciary and do you acknowledge this in writing? (If you’re already working with someone and are unsure of their status, it’s a good idea to call them up and ask them.) A financial advisor held to a fiduciary standard occupies a position of special trust and confidence when working with a client. As a fiduciary, the financial advisor is required to act with undivided loyalty to the client. This includes disclosure of how the financial advisor is to be compensated, elimination of any significant conflicts of interest to the extent possible, and full disclosure of any remaining significant conflicts of interest. In other words, the financial advisor must place their client’s interests first.

Our website specifically states, “As a fee-only financial advisor, our revenues derive solely from fees paid directly to us by our clients. We have no potential conflicts associated with commissions or proprietary products.”

Our firm charges fees based on the amount of money that we are managing for our clients (i.e., assets under management). If you are a client of our firm and are interested in paying off a mortgage to free yourself of the debt, we acknowledge the potential conflict of interest that exists in you withdrawing money from the portfolio and the resulting drop in our fees, but we will help you make the right decision. In fact, over the last few years, we have helped many clients pay off their mortgage. It’s with this peace of mind that they can sleep comfortably knowing that we are on their side.

Let’s say that you just found yourself the recipient of an inheritance or a large bonus check and are thinking about possibly investing it in your portfolio. Without this fiduciary relationship, the answer would be simple: invest everything, because the more you invest, the more fees the firm will reap. But that’s not how we answer the question. We would want to know whether you expect to make any significant withdrawals from the portfolio during the next five years. We do not believe any investor should invest money in the market if they expect to need it back within the next five years. If you’re likely to need funds annually to supplement other outside income, we would make sure that you have enough cash set aside in case the markets go down so that you don’t have to sell anything in the next year and you know exactly where your grocery money will come from. Once again, the decision is not how to maximize our short-term profits; instead we are looking to make smart decisions that will benefit our clients.

On the other hand, brokers and other commission-based advisors are held to a “suitability” standard, which states that they must recommend a product that is suitable for the client, but that may not necessarily be the best recommendation for that person. For example, you’ve probably seen situations where a representative from XYZ Company recommends buying the XYZ Bond Fund, the XYZ Large Cap Growth Fund, and the XYZ International Fund. Is it really likely that XYZ Company could have the best mutual fund in every category?

Fees, fees everywhere

Some firms charge an annual rate, some charge based on assets under management, and some build the fees into the stock and bond transactions. None of these are inherently unfair as long as you know exactly how the advisor is getting paid, whether the fees are reasonable, and what their duty is to you (i.e., business standard or fiduciary). There may also be additional fees—such as mutual fund expenses, transaction fees, account opening or closing fees, and such—so it’s important to know how much those fees are and who receives those fees. At our firm, we use no-load mutual funds and exchange-traded funds. As there are no commissions involved, these investments have relatively low expense ratios, and fees are paid directly to the fund companies. There are small transaction fees as well, and these fees are paid directly to the custodian. We are paid only by our clients, who receive a bill each quarter with the calculation and amount of those fees. Performance is calculated net of fees where possible so that it’s in our best interest and the client’s best interest to limit all fees as much as possible.

You should always be aware of conflicts of interest as they pertain to fees. Will buying the mutual fund, annuity, or life insurance contract primarily benefit you or the person selling the product? The type of legalese you might look for is something to the effect of “Your account is a brokerage account and not an advisory account. Our interest may not be the same as yours … We are paid both by you and, sometimes, by people who compensate us based on what you buy. Therefore, our profits, and our salespersons’ compensation, may vary by product and over time.” (Italics are my emphasis.)

For example, a representative at the XYZ firm may recommend a high-yielding bond to their client. What the client doesn’t know is that the firm is trying desperately to sell the bond to everyone it can so that it doesn’t have to keep the bond on its books due to expected losses (I have taken this example from the book Liar’s Poker by Michael Lewis, a nonfiction book describing his experience as a bond salesman in the 1980s). Who is the best prospect to sell the bond to? Their client, of course. They can do this because as long as the client asked for income in their portfolio, this investment would be suitable.

None of this by itself implies that there is anything wrong with compensation by way of commission. The bottom line is that you, as the client, need to understand how the advisor is getting paid, whether they are being held to a fiduciary or suitability standard, and whether these details are in writing. If in doubt, simply ask your advisor if they will sign a statement similar to the following:

  • In our relationship I will always place your interest first.
  • I will act with prudence; that is, with the skill, care, diligence, and good judgment of a professional.
  • I will not mislead and will provide you with conspicuous, full, and fair disclosures of all important facts.
  • I will avoid conflicts of interest.
  • I will fully disclose and fairly manage, in your favor, any unavoidable conflicts.

It’s time that we break down the confusion surrounding investment professionals so that the public understands who their Jiminy Cricket is.

Feel free to contact Brett Horowitz with any questions by phone 305.448.8882 ext. 216 or email: BHorowitz@Evensky.com

For more information on financial planning visit our website at www.Evensky.com

 

 

Unexpected Expenses When Buying a Home

Roxanne Alexander

Roxanne Alexander, CAIA, CFP®, AIF®, ADPA® Senior Financial Advisor

Buying a new home can be an expensive process, and if you are not careful, you can end up paying for items you don’t need or have already paid for.

Loan Costs

When applying for a mortgage and receiving quotes from various mortgage companies, make sure you are comparing apples to apples. You will want to find out the average closing costs in your state or county and compare them to what you are being offered. There are some costs which are fixed, such as recording fees and transfer taxes, but there are other costs you can shop around for, such as title and insurance fees. These numbers can vary quite widely depending on the lender.

If you get a quote for a fixed-rate mortgage and have it locked or remove escrow, make sure you don’t see points added to your closing statement that you didn’t agree to. Paying points may not be worth it unless you plan to keep the loan for a long time. Points do lower your interest rate and your monthly payment, but it takes some time to break even.

For example, assume the monthly payment difference between paying 1.125 in points vs. no points is $64 per month, which is $768 per year. If it costs roughly $6,000 to pay points, it will take you around eight years to break even. Paying points may make sense over the long term provided you plan on living in the home indefinitely or possibly keeping it and renting it out in the future. If you think you are going to sell and move in less than eight years, paying points is more expensive.

You probably should avoid escrow if you are disciplined about setting aside funds. Paying escrow gives the bank extra funds to hold on to for you to pay taxes and insurance when you could be earning some interest on those funds in the interim.

Check your closing statement in detail and make sure everything you have already paid is included in the calculation. You may be surprised to find that the numbers sometimes don’t add up if you plug all the line items into a spreadsheet. You may save yourself from overpaying if you happen to find a mistake. You will sometimes be asked to pay a good-faith deposit when moving forward with a lender. This deposit is usually applied toward the appraisal or other fees, so make sure you are not charged twice.

Quick mortgage checklist:

  1. Compare interest rates and closing costs being offered. Are points being paid? What is the percentage difference between variable rates and fixed rates?
  2. Make sure lenders do not tack on points after they have locked your rate (unless you intentionally want to pay points and agreed to this in advance).
  3. Make sure any items you have prepaid are not included again in the closing costs.
  4. Make sure the lender does not add escrow unless you want it.
  5. The buyer has the right to use their own attorney or title company – you may be able to lower title costs if you shop around.
  6. The lender may ask you to pay a good-faith deposit, which they usually use for appraisal, etc. Make sure you get that back as a credit.
  7. Check your property tax calculation against the property appraiser’s website or property tax bill.

 

Homeowners associations

If the home is covered by a homeowners association, read the condo documents to make sure there are no rules and restrictions that you cannot live with, such as rules against pets (if you have them) or alterations you are planning to make. Pay attention to the association’s financial statements, since this will give you clues on potential assessments, whether there are enough reserves for large repairs, or if you will have to find a lump sum when the roof needs to be replaced or the house painted. You will also want to find out if there are any outstanding lawsuits or liabilities against the association.

Inspection and property disclosure

You are not obligated to use the inspector recommended by the realtor, title company, or lender. It is usually best to shop around for someone you trust who is independent from all the other parties that have interest in the deal. Some inspectors just go through the motions and miss checking the smaller problems, which can end up costing you money later on. You want to make sure the appliances are all in working order and that you are aware of when the air conditioner and water heater, etc., were last replaced or serviced. The inspector should check all the electricals and plumbing to make sure everything is in working order. It is advisable to verify that all permits have been closed out and that new construction meets code if the previous owner made any major renovations.

Homeowners insurance

Insurance is sometimes included in the mortgage estimate and is usually quoted higher than you would actually pay on your own. Shop around and don’t assume the number they state is what you will ultimately have to pay. You will need to purchase homeowners insurance prior to closing. Find out if the association covers any of the insurance costs, as this may be included in your maintenance fees. This lowers your costs of insurance, since you only have to insure contents and fixtures.

Homestead and property taxes

Property taxes are usually paid up once the sale goes through. Closing agents make estimates on the property taxes, which may be higher than the actual taxes stated on the county property appraiser’s website. Check the closing statement to make sure the taxes match what needs to be paid and that you are not overpaying. You should only be responsible for the portion of the year you own the home. For example, if you close on October 31, you should only be responsible for the days in November and December. If taxes are $8,500 for the year, then a rough calculation would be $8,500/365 = $23.28 per day x 61 days = $1,420.

Feel free to contact Roxanne Alexander with any questions by phone 305.448.8882 ext. 236 or email: RAlexander@Evensky.com

For more information on financial planning visit our website at www.Evensky.com

 

 

Start Thinking about End-of-Year Tax Planning Now

David Garcia

David L. Garcia, CPA, CFP®, ADPA® Principal, Wealth Manager

Most folks hate to think about paying taxes, let alone end-of-year tax planning strategies. Unfortunately, ignoring tax planning can lead to paying Uncle Sam more than is required. The last four years have seen the introduction of new income-based Medicare premium increases along with increases in the top income tax, capital gains, and dividend rates. Starting to plan as early as possible is crucial since most strategies need to be completed prior to year end. Depending on your situation, it may make sense to either accelerate or delay deductions and income. This blog post briefly discusses some of the most often used tax planning strategies, but is by no means an exhaustive list. Tax planning strategies can be complex and should always be considered in close consultation with your accountant and financial advisor to make sure decisions are made with your unique tax situation in mind.

Harvesting Losses

At first glance, it may seem silly to intentionally sell an investment for a loss. However, opportunistic tax loss harvesting can boost after-tax returns. Suppose you have a $50,000 investment in the U.S. stock market via a broad market index fund that loses 10% of its value this year. You can sell this index fund and turn around at the same time and buy a very similar U.S. index investment, losing no market exposure but banking a $5,000 loss for tax purposes. This can be a beneficial tool for reducing taxes while maintaining your asset allocation and risk/return profile. Even if you do not have any gains to apply the loss to in the year of sale, up to $3,000 can be used against ordinary income items such as wages. Further, any excess unused loss is carried forward to be used in future tax years.

There are some important limitations to tax loss harvesting that should be kept in mind. The IRS will not let you sell an investment and at the same exact time buy back that identical investment just to create a tax loss. IRS rules state you must wait 30 days to purchase the identical investment sold for the loss or you violate what is commonly referred to as the “wash sale rule.” A wash sale disallows the loss for tax purposes. However, IRS rules do allow you to purchase a very similar investment, preferably one that is highly correlated with the investment sold for a loss, without breaking the wash sale rule. For example, selling the S&P 500 SPDR and replacing it with the Vanguard total stock market index would give almost identical market exposure while not violating the wash sale rule.

The bottom line is that actively managing capital gains and losses near year end can increase after-tax returns over time. Just be sure to consult with your accountant or investment advisor to make sure you do not run afoul of any limitations.

Medicare Premiums for High-Income Earners

In 2016, some Medicare recipients began to see an additional 16% base premium increase set into motion by two different laws. One law says that ordinary recipients can’t have their standard premium go up by more than the Social Security cost of living increase for that year. Since there was no cost of living increase in 2016, this benefited about 70% of beneficiaries. Unfortunately, another law shifted the burden of increasing Medicare costs onto the remaining 30% of beneficiaries. This unlucky 30% includes folks who don’t deduct Medicare premiums from their Social Security checks, those who didn’t receive Social Security in 2015, and high-income earners.

If that wasn’t bad enough, on top of the 16% base increase, Medicare also penalizes about 5% of high-income beneficiaries with premium surcharges. The surcharges begin at adjusted gross income levels above $85,000 for singles and $170,000 for married folks filing jointly. To make matters worse, the income thresholds are currently not indexed for inflation, so more people will be affected by the surcharges in coming years. Tax planning can help reduce the bite of surcharges.

The Medicare surcharges are determined by a taxpayer’s modified adjusted gross income (MAGI). For most folks, this is adjusted gross income plus tax-exempt interest. This number is calculated before itemized deductions, so the usual deductions like charitable donations and mortgage interest won’t help. However, if you are charitably inclined, there is one strategy that might help reduce your MAGI. If you have to make a required minimum distribution (RMD) from your IRA every year, the distribution goes on your 1040 as ordinary income and increases your MAGI. The IRS allows you to give up to $100,000 of your RMD to charity and have it avoid your 1040 all together, thereby directly reducing your MAGI. Other strategies beneficiaries may want to consider include harvesting capital losses to offset gains that increase MAGI, moving forward or putting off income events in the current tax year, and utilizing Roth accounts for income. The bottom line is that a little planning could save you a lot in Medicare premiums.

Roth Conversions

In 2010 Congress repealed the income limit on Roth IRA conversions affording taxpayers, regardless of their income, the opportunity to pay off the embedded tax liabilities in their IRAs. Taxpayers who take advantage of Roth conversions should consult with their tax professionals and financial advisors to make sure converting to a Roth IRA makes sense for their particular situation. Even though converting traditional IRA assets to a Roth IRA creates current income tax, there are several situations where it may make sense to perform a Roth conversion. Perhaps you have retired recently and find yourself in a low tax bracket, making a Roth conversion less expensive. Many people convert IRA assets because they want to create a tax-free retirement asset for their heirs or to use up operating losses from their business. Whatever your reason, your future tax bracket, time horizon, estate plans, and whether you have cash outside of your IRA to pay the conversion taxes should all figure into your decision.

Conclusion

Tax planning is an important part of everyone’s financial plan. Most people approach tax issues in a reactive manner instead of being proactive. By starting to think about your current tax circumstances before year end, you may save yourself taxes and take advantage of opportunities on which you may otherwise miss out.

Feel free to contact David Garcia with any questions by phone 305.448.8882 ext. 224 or email: DGarcia@EK-FF.com.

 

Kitces, Michael E. “Planning for the New 3.8% Medicare Tax on Unearned (Portfolio) Income.” Nerd’s Eye View. N.p., Apr. 2010. Web. <www.kitces.com>.

“Medicare Premiums: Rules for Higher-Income Beneficiaries.” Social Security Administration. N.p., Jan. 2016. Web. <www.socialsecurity.gov>.

“Advanced Tax Strategies Using a Roth IRA Conversion.” Putnam Investments. N.p., n.d. Web. 19 July 2016. <www.putnamwealthmanagement.com>.

Cubanski, Juliette, Tricia Neuman, Gretchen Jacobson, and Karen E. Smith. “Raising Medicare Premiums for Higher-Income Beneficiaries: Assessing the Implications.” Kaiser Family Foundation. N.p., Jan. 2014. Web. <www.kff.org>

Taxes: It Pays to Treat Them Right

HRE PR Pic 2013

Harold Evensky CFP® , AIF® Chairman

I know how most people feel about taxes: don’t tax me, don’t tax thee, tax the man behind the tree. Unfortunately, ultimately we gotta pay. Everyone’s interested in minimizing the pain and that’s why I’m sitting here trying to put together a talk on tax planning for our local Rotary Club. It’s a great group of sophisticated professionals, and I don’t want to talk down to them, but I do want to provide some useful information.

Trying to balance those issues reminded me of a complaint one of my client’s accountant had about how we had selected some of his bond investments. I remembered that sophisticated doesn’t necessarily mean knowledgeable. So here’s what I came up with:

Don’t Let the Tax Tail Wag the Dog

The accountant’s complaint about our choice of bonds was a result of his focusing on the tax tail. Our client was in a moderately high tax bracket; however, we had his short-term, fixed-income investments in corporate bonds. “Move ’em to tax-free municipals” was the accountant’s advice. Well, it’s true, our clients would have paid less tax if we’d invested them in municipal bonds, but they would also have had a lower after-tax return. Why? At the time, taxable bonds were paying 5 percent and similar quality and maturity municipals were paying 3¼ percent. That meant our 30 percent marginal tax bracket client had a choice of earning 3¼ percent with no tax obligation or 5 percent with the obligation of paying 30 percent of his interest payments to Uncle Sam. Which would you choose? I hope the 5 percent.

Even if you peel off the 30 percent tax bite, that would leave 3½ percent in your pocket. It’s not rocket science to see that 3½ percent is better than 3¼ percent. The moral? When choosing between equivalent-quality taxable and tax-free investments, don’t worry about how much you’ll have to pay Uncle Sam (even if painful). Instead, keep your eye focused on how much you’ll have after paying taxes.

Turnover Doesn’t Tell All

It’s common for investors to use turnover as a measure of tax efficiency. Don’t do it. When you look at an investment’s turnover number, it’s natural to think it represents a pro-rata turnover of all the securities in the portfolio. For example, a 60 percent turnover would mean that 60 percent of the positions in the portfolio are sold in one year. Sound reasonable? As my brother, the economist, would say, au contraire. A 60 percent turnover doesn’t necessarily mean that 60 percent of the stocks have been traded. It might well mean 20 percent of the stocks have been traded three times. All of those trades may have been the sale of stocks with losses, not gains, so the manager not only generated no tax bite, he also realized losses that can shelter future gains.

And the Rest of the Story (the Most Important Part)

Taxes are a function of something called a holding period, not turnover. The holding period is the average number of years it would require to turn over all of the positions in the portfolio. To explain: let’s assume that the manager has a portfolio chock full of stocks with taxable gains and he is trading all of the stock in his portfolio pro rata. So a 20 percent portfolio turnover would mean one-fifth of the stocks would be sold each year, or 100 percent in five years. That means, on average, the manager holds stocks for two and a half years.

Obviously, a portfolio with a 90 percent turnover would realize pretty much all of the gains in the first year, which means lots of taxes; consequently, a 50 percent turnover sounds a lot better. But if you think about it, 50 percent means selling one-half this year and paying the taxes, and one-half next year with more taxes. The difference between paying all of the taxes in year one versus one-half of them in year one and one-half in year two is negligible. The graph below shows the relationship. Unless turnover is very low—less than 10–15 percent, there is no real tax efficiency.

The moral? Avoid the murky middle. A few years ago, my partner, Deena Katz, and I co-edited a book called the Investment Think Tank (Bloomberg Press). We invited several friends (practitioners and academics) to contribute chapters on subjects they believed were of vital importance for advisors.

Recognizing the importance of the holding period, Jean Brunel, managing principal of Brunel Associates, introduced the concept of the murky middle. He noted that the more active the manager, the more you’d expect him to add value. After all, why would you want to pay the trading cost and suffer the tax inefficiency of active trading if you weren’t rewarded with extra net returns? He also noted the reality of the elbow graph above: no matter the manager’s intention, as turnover increases a tax-efficient manager will be no more tax efficient than a tax-oblivious manager.

Brunel’s excellent advice is to avoid the murky middle—hire very low-turnover managers (indexes and ETFs) when you want to just capture market returns. Hire go-go, active managers with the funds you’re prepared to invest at higher risk to earn better-than-market returns. Stay away from those managers who, for marketing purposes, try to straddle the fence, going for both tax efficiency and extra return. They may have performance numbers that look good before taxes, but after taxes, the numbers don’t look so good. Here’s how Brunel depicts the murky middle:

I think my Rotary audience will like this talk. For more on the murky middle, check out Chapter 3, “Net, Net, Net: Expenses, Taxes, and Inflation Can Eat Your Nest Egg – What To Do?”

This blog is a chapter from Harold Evensky’s “Hello Harold: A Veteran Financial Advisor Shares Stories to Help Make You Be a Better Investor”. Available for purchase on Amazon.

Pay Taxes Now or Later? Traditional 401k vs. Roth 401k

Katherine Sojo

Katherine Sojo, CFP® Financial Advisor

If your employer offers you a traditional 401k and a Roth 401k, you might find yourself wondering what the difference is and why it matters. Traditional and Roth 401ks have several similarities such as that they are only offered by employers, the contribution limits are the same ($18,000 for 2017 plus $6,000 if you are over the age of 50), and the employer match is always pretax regardless of which option you choose. The biggest difference between a Traditional 401k and a Roth 401k is the timing of payment of taxes. In a Traditional 401k, your contribution is termed as pre-tax dollars; you receive an upfront tax break, reduce your taxable income, and pay the taxes when you take the funds out during retirement. The money withdrawn at retirement from a Traditional 401k is taxed as ordinary income using your tax rate at that time. A contribution to a Roth 401k is termed as after-tax dollars; this means you pay taxes on the contribution now, at your current tax rate, and therefore during retirement you withdraw the money and the earnings tax-free.

How do I decide? Ask yourself the following questions:

  1. Do I want to pay taxes now or later? What is my tax rate differential? If you believe you are in a lower tax bracket today and will be in a higher tax bracket during retirement, then paying the taxes now by funding a Roth 401k is a good option. If you believe you are in a higher tax bracket today and will be in a lower tax bracket during retirement, then funding a Traditional 401k and paying the taxes later is a good option.
  2. Can you afford to pay the taxes now? Knowing what the actual tax dollar benefit of a pre-tax or after-tax contribution means for your pocket is also a deciding factor (your tax advisor can help with this calculation). If you pay the tax now (Roth 401k), then your paycheck will decrease; therefore, you will have less money to cover expenses and/or less money for additional outside savings. A traditional 401k provides for a current tax deduction that results in some extra cash in your pocket now.
  3. Do you distrust future tax regulations? Do you believe taxes will increase in the future? If so, then taking advantage of a lower tax bracket now will signify contributing to a Roth 401k. Do you believe taxes will decrease in the future? If so, then hold off on paying taxes on the contribution until retirement and utilize a Traditional 401k.

There is also an argument for using a combination of both a traditional 401k and a Roth 401k to diversify your tax exposure. A combination of the two can provide some upfront tax benefit and also some protection on any tax rate changes in the future. It is not a simple decision, but truly thinking about your answers to the questions above can help you make the best decision possible for your retirement planning.

Feel free to contact Katherine Sojo, CFP® with any questions by phone 305.448.8882 ext. 243 or email: KSojo@EK-FF.com.

Understanding Estate Exemption Rules

DavidGarcia_175x219

David L. Garcia, CPA, CFP®, ADPA®

In the beginning of 2013, Congress made the estate tax exemption permanent at $5 million per person, the 2012 rate, but adjusted the amount for inflation each year going forward. For 2016, the estate and gift tax exemption stands at $5.45 million per person. Congress also made another very popular component of the estate tax law, called “portability,” permanent. Portability allows spouses to combine their estate tax exemptions, effectively letting married couples give away or leave almost $10.9 million without owing estate tax.

Couples and their advisors must be diligent in making sure they get the benefits of portability since it is no longer automatic. The IRS recently issued final rules concerning the requirements for electing portability of a deceased spouse’s unused exemption amount. There still exists an unlimited marital deduction which allows you to leave all or part of your assets to your surviving spouse free of federal estate tax. However, to use your late spouse’s unused exemption, you must elect it on the estate tax return of the first spouse to die. This rule applies even if the first spouse doesn’t owe any estate tax. Generally, an estate tax return is due nine months after the date of death. A six-month extension is available if requested prior to the due date. This makes it imperative that high-net-worth people educate themselves on what portability is and how to elect it. Failure to follow the finalized rules may result in considerably higher estate taxes.

Of course, just because the estate exemption was made permanent in 2013 doesn’t mean the government can’t change the law in the future, but the current makeup of Congress makes it unlikely in the short-to-intermediate term. There has been a lot of activity in this area of the law over the last decade, so if you haven’t had your current estate strategy reviewed by your attorney in the last five years, it’s probably time for an estate checkup.

Feel free to contact David Garcia with any questions by phone 305.448.8882 ext. 224 or email: DGarcia@ek-ff.com