Financial Ducks In A Row • Independent financial advice: IRA, Social Security, income tax, and all things financial

Posted in: fee-only, fiduciary, financial planning.
Tagged: fiduciary · financial planning

Mechanics of 401(k) Plans – Saving/Contributing

May 5th, 2014

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Image courtesy of Ppiboon at FreeDigitalPhotos.net

Many folks have a 401(k) plan or other similar Qualified Retirement Plan (QRP) available from their employer. These plans have many names, including 403(b), 457, and other plans, but for clarity’s sake we’ll refer to them all as 401(k) plans in this article. This sort of retirement savings plan can be very confusing if you’re unfamiliar, but it’s a relatively straightforward savings vehicle.

This is the first in a series of articles about the mechanics of your 401(k) plan – Saving/Contributing.

Saving/Contributing

You are allowed to make contributions to the 401(k) plan, primarily in the form of pre-tax salary deferrals. You fill out a form (online most of the time these days) to designate a particular portion of your salary to be deferred into the 401(k) plan. Then, each payday you’ll see a deduction from your paycheck showing the 401(k) plan contribution. The deduction is before income tax withholding is applied to the paycheck, since these contributions are “pre-tax”. However, Social Security and Medicare taxes are applied to these deferrals.

Because of this pre-tax nature of your deferrals into the 401(k) plan, putting money in the plan will reduce your income taxes in the year of the deferral. For example, if your income is $30,000 per year and you defer 5% of your income into the plan, your reported taxable wages would be 5% less, or $28,500. As a result, your possible tax bill could reduce from $2,553.75 to $2,328.75, a reduction of $225. (This is an example only, using 2013 tax tables.)

Once your money is deferred into the plan you will be eligible to invest those funds as you see fit (we’ll get to the investments in a later post).

The deferred funds are your money. You earned it, just the same as your take-home pay. The only way you lose this money is by investing in a security that loses money, such as a stock that goes bankrupt. Otherwise, no one can take this money away from you. When money is deferred to the plan you have an increase to the balance in your 401(k) plan just the same as your checking account increases with the direct-deposit of your take-home pay.

Roth 401(k)

Depending on your company’s plan, you may have a Roth 401(k) component available to you. The mechanics are similar to the garden-variety traditional 401(k) plan – except that your contributions are post-tax, rather than pre-tax. So the changes to your tax mentioned above do not apply to contribution made to a Roth 401(k) plan. Then, when you take the money out of the Roth 401(k) account at retirement (as long as you’re at least age 59 1/2 years of age) there is no tax on those withdrawals. We’ll provide more detail on withdrawals in a later post.

If you have a Roth 401(k) plan available to you, it is simply another component of the overall 401(k) plan. You have a choice as to whether or not your deferrals to the plan are made to the traditional 401(k) plan or the Roth 401(k) plan, and you can contribute any amount (up to the maximum) to the combination of these two plans in the tax year.

Annual Maximum Contributions

Each year the IRS provides guidance about the maximum annual contribution that can be made to a 401(k) plan. For 2014, this maximum contribution is $17,500, and if the employee-participant is over age 50, an additional $5,500 “catch-up” contribution can be made for the tax year. This could be as much as 100% of your annual contribution, if you wish.

If you are employed by more than one employer, this annual limit applies across the board to all plans that you might contribute to collectively (with one exception, below). So if you have a second job where you can contribute to a 401(k) plan in addition to your primary job, you can only contribute up to $17,500 in total to all plans for 2014 (plus the $5,500 catch-up if over age 50).

Exception

Earlier, I mentioned that we were referring to all QRPs as 401(k) plans because they are much the same. One difference comes about with annual contributions: 457 plans have the same limit as 401(k) plans, but are not subject to the “collective” limit mentioned above. So if your employer provides both a 457 plan and a 403(b) plan, for instance, you could defer up to double the annual maximum contribution to these two plans – $35,000 (plus $11,000 if over age 50) for 2014.

Posted on May 5th, 2014

by author: jblankenship.

Posted in: 401k, 403 b, 457, qrp, qualified retirement plan, retirement plans, retirement savings, roth 401 k.

Trust, But Verify

May 2nd, 2014

by sraskie.

1 comment

Since late 2012 I have had the honor to provide financial counseling to our service members generally going to different military installations to talk to soldiers and their families regarding financial issues such as buying a home, saving for retirement, reducing and eliminating debt, or simply creating a budget. On my very first assignment I ever did, I pulled up to the base entrance – a heavily fortified gate and entrance – and was asked to park my vehicle to the side while they ran my ID and searched my vehicle for any contraband. There’s something humbling yet cool about being searched by military police with automatic weapons.

Naturally, other than remnants of a snack left over from my kids or an empty water bottle there was no contraband and I was free to close my vehicle up and drive to where I would be working for the day. This common routine has gone on several times at the same installation particularly.

A few months ago, I pulled up to the gate and was greeted by a soldier whom I’ve come to know and recognize and vice versa. When I handed him my ID he said, “I know who you are, sir, and welcome back.” He then went on to say, “I’m sorry sir, but I’m going to have to ask you to pull your vehicle over, open the doors, hood, glove box, console, and please turn off your engine.” He continued, “I know you’ve been here many times, but we have to follow protocol.”

Naturally, I don’t argue and am more than happy to comply. I’ve built rapport and trust, but they still have to verify.

The same is true with your financial planner, insurance agent, advisor, or other professional. It doesn’t hurt to verify things they say or reports they give. I’m not saying to never trust them or be leery, but I am saying it’s ok to check up on their work, advice and numbers every so often.

For example, I’ll encourage clients to check me out independently of our website or what I’m saying. One of the first places I recommend is www.brokercheck.com which is an excellent way to look at a financial advisor’s history, record and possible affiliations with other companies. If he or she is a CFP®, ChFC®, CLU®, etc., verification of their designations can be found at www.cfp.net for the CFP® and www.designationcheck.com for the ChFC® and CLU®.

Verifying numbers and returns can be a bit trickier, but certainly doable. It never hurts to investigate yourself or if you feel comfortable, getting a second opinion. Ask questions about gross versus net returns, fees, expenses, and compensation. Visiting www.morningstar.com is another great way to investigate recommended mutual funds, stocks, bonds and portfolio allocations.

Finally, it never hurts to trust your gut. If something sounds too good to be true it usually is. If something just doesn’t sound right, it’s probably wrong. If something doesn’t make sense to you, it probably doesn’t make sense. And if the advisor, agent, professional can’t explain how the product works or how they get paid – run.

Posted on May 2nd, 2014

by author: sraskie.

Posted in: fee-only, fiduciary, financial planning.
Tagged: fiduciary · financial planning

Book Review: Facing the Finish–A Roadmap for Aging Parents and Adult Children

Apr 28th, 2014

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One of life’s only sureties, we all will eventually come face-to-face with the end of our life. Sometimes it comes quickly with no warning, and sometimes end of life comes more slowly, over the course of many months or years. In either case, after life there are many things to deal with (for those that remain) – and in the cases where the final chapter of our life is a lengthy one, there are many more decisions to make and situations to deal with. Regardless of how swiftly or drawn out the event is, we can all benefit from planning out many of the inevitable decisions in advance.

This book is an excellent guide for folks who are either nearing that final transition in life (referred to by the author as Older Adults), or who are helping our parents or grandparents with this transition (referred to as Adult Children). Most everything that you need to consider about this transition is covered here, from decisions about your personal and financial affairs, involving your family in decision-making (where appropriate), decisions about care and housing, as well as how to finance your final chapter of life.

The book was written by Sheri L. Samotin, who is a life transitions coach, National Certified Guardian, and certified Professional Daily Money Manager and the founder of LifeBridge Solutions LLC. Ms. Samotin brings her wealth of knowledge and experience in helping Older Adults and their Adult Children deal with the challenges of aging. With these insights Samotin provides many real life examples to illustrate her points, which help to personalize the lessons.

I believe that all persons, whether Older Adults or Adult Children, can get a great deal of benefit from this book. The author brings to the fore many salient points that you might not otherwise have considered as you face this transition, from either point of view (Older Adult or Adult Child). It’s a relatively short read (roughly 200 pages) and is written in an easy, conversational style (not full of technical jargon!). I will recommend this book for clients in either situation who are looking for just such a roadmap (and even if they don’t know they’re looking for such a roadmap!).

Posted on Apr 28th, 2014

by author: jblankenship.

Posted in: Book review, estate planning.
Tagged: book review · estate planning

Do I Need My Life Insurance Through Work?

Apr 25th, 2014

by sraskie.

4 comments

Berry Hard Work (Photo credit: JD Hancock)

Many employees have access to employer provided benefits such as health insurance, a retirement savings plan disability insurance and life insurance. Generally the coverage is group term coverage that will pay a specified death benefit up to a certain amount that is usually based on a multiple of the employee’s salary.

An employee making $50,000 per year may have group term life insurance that pays a death benefit of $40,000. Generally the employer will pay the premium for coverage up to a certain death benefit amount. Usually this amount is $50,000. The reason why is the IRS allows the employer to pay the premiums on a group life insurance policy up to a face amount of $50,000 without the employee having to include the amount the employer pays for premiums in gross income. Sometimes the employee can elect to have coverage for a higher amount but will most likely have to pay the difference between what the employer pays and the death benefit from that amount and the amount of the increase in the premiums paid for the extra death benefit.

For example, an employer may pay the premiums for the first $50,000 in death benefit but allows the employee to elect up to 5 times their salary for group term coverage. If the employee chooses 5 times their salary they will have a $250,000 death benefit. The employee will pay the premium for the additional $200,000 in coverage.

So is employer sponsored life insurance a good deal? You bet it is! Generally this is the most insurance a person can get with almost no underwriting involved. This means a person in poor health or with a pre-existing condition may get coverage for pretty cheap. For many, this is the only insurance they can get due to health or affordability.

If you can, it makes sense to buy the most group term life insurance you can buy. Supplement any additional term insurance need with coverage from a reputable insurance company.

Some employer policies are portable which means that the coverage can be taken after the employee leaves their employer. This is usually done via conversion – the group term policy converts to an individual permanent policy such as whole life or universal life. Conversion can be done without having to go through underwriting, however the premiums will likely be sky high.

This can make sense if it’s the only insurance someone can get and they still have a need. If they can get an individual term policy, this is almost always the best way to go. They can get underwritten for any term length they need – 10, 20, or 30 years and the premiums will be based on underwriting and term length.

Another idea to consider is buying a large term policy individually and then supplementing the maximum you can get through your employer. That way you’ll always have you own policy regardless of what happens to your employment.

Posted on Apr 25th, 2014

by author: sraskie.

4 comments already - add to the conversation!

Posted in: life insurance, personal finance.
Tagged: fiduciary · financial planning · life insurance

Be Careful When Converting

Apr 23rd, 2014

by sraskie.

5 comments

Conversion of St Paul (Photo credit: Lawrence OP)

When converting from a 401(k), traditional IRA, 403(b), SIMPLE IRA, SEP or 457(b) to a Roth IRA there are some important tax considerations to keep in mind.

First, converting from a tax deferred plan to a tax free plan it’s not always the best idea. Generally, it’s going to make sense to convert if the tax payer believes that he or she will be in a higher income tax bracket in retirement. For example, John, age 28 has a 401(k) and recently left his employer. He’s currently in the 15% bracket but expects to be in the 28% bracket or higher in retirement. It may make sense for John to convert his 401(k) to his Roth IRA.

This makes sense for John because when he converts from a pre-tax, employer sponsored plan like the 401(k) it’s money that has not yet been taxed. If he converts while in the 15% bracket, that money is now subject to tax at the 15% rate, and arguably a lower amount of money being taxed since he’s still young. If he decided to wait until retirement to convert (let’s assume he’s in the 28% bracket) then that money is going to be taxed at 28%, or almost twice the rate if he had converted when he was in the 15% bracket. John has also eliminated future RMDs as Roth IRAs have no such requirement.

Generally, it may make sense to not convert if you expect to be in a lower tax bracket at retirement. The reason is you’d convert at a higher tax bracket today, only to be in a lower bracket in retirement. Thus, you’ve paid a higher than necessary amount of tax on your money.

Second, when converting, pay close attention to you your age and how you choose to “pay” the tax. Let’s look at two examples.

Let’s say John in the example above decides to convert when he leaves his employer at age 28. He’s saved a nice sum of $100,000 in his 401(k). He decides to convert to a Roth IRA at the 15% bracket. He elects to pay the tax himself from outside of the 401(k), that is, he elects to not have any tax withheld from the conversion. He decides he’ll pay the tax from another source when tax time comes around. All is being equal, John owes $15,000 at tax time.

This turns out to be a very wise decision for John. Here’s why.

Let’s assume the same scenario above except that John decides to have the $15,000 withheld from his 401(k) to pay the taxes on the conversion. Remember how old John was? 28. He’s under age 59 1/2 and the $15,000 withheld for taxes is considered an early distribution, and, you guessed it, subject to the 10% early withdrawal penalty. So instead of paying $15,000 in taxes, John pays an additional $1,500 due to the 10% penalty or a total of $16,500.

It pays (either you or the IRS) to consider the tax ramifications of converting to a Roth IRA. Talk to an experienced financial planner and or tax advisor for help.

Posted on Apr 23rd, 2014

by author: sraskie.

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Posted in: conversion, conversions, fee-only, fiduciary, financial planning, IRA, Roth conversion, roth conversion, Roth Conversion, roth ira conversion.
Tagged: 401 k · financial planning · income tax · roth conversion · roth ira

Tax Time is Over. Maybe.

Apr 21st, 2014

by sraskie.

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For most folks tomorrow marks the one week anniversary of filing their 2014 tax return. Not much needs to be done after they’ve filed except for deciding to have more withheld in 2014 for those folks who had to write a check to Uncle Sam or deciding what to do with the refund (hint: put it in an IRA) for those folks who got a refund.

What happens when the return may have been submitted with mistakes or perhaps costly errors? Generally, if the error is minor the IRS will correct errors or accept returns without certain forms or schedules attached.

For those returns that have a change in filing status, income, deductions, and credits then filing an amended return will most likely be appropriate. For those folks needing to file an amended return they are allowed to file using form 1040X. Form 1040X will allowing corrections to earlier filed returns that used 1040A, 1040EZ.

If a person needs to file for separate years then a separate 1040X must be filed for each tax year that’s being amended.

According to IRS topic 308 keep the following points in mind:

Attach copies of any forms or schedules that are being changed as a result of the amendment, including any Form(s) W-2 received after the original return was filed.
Tax forms can beobtained by calling 800-829-3676 or visiting www.irs.gov.
An amended tax return cannot be filed electronically under the e-file system.
Normal processing time for Forms 1040X is up to 12 weeks from the IRS receipt date.

Generally if a refund is to be claimed the amended return needs to be filed within 3 years after the due date of your original return or 3 years after the date you filed your return if you filed for an extension.

Posted on Apr 21st, 2014

by author: sraskie.

Posted in: #noTOP, amended return, tax, tax preparers, tax return.
Tagged: income tax · tax · tax preparers

Do Unto Others?

Apr 18th, 2014

by sraskie.

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In the financial services industry there has been considerable discussion on the application of the fiduciary standard of care for clients versus the suitability standard of care. There are generally two sides to the argument: on the fiduciary side the standard of care is to act in the best interests of the client (the standard that Jim and I are held to and embrace) and the other side which is a suitability standard of care in which the recommendation needs to be suitable, but not necessarily in the best interest of the client.

This is where things get sticky.

Acting in the best interest of the client is pretty cut and dry. After extensive questioning and gathering of information a recommendation is made to the client based on what is best for their situation. This means recommending keeping the current course of action, following a designed and carefully thought out plan, or recommending the client do business elsewhere.

Suitability on the other hand requires only finding an appropriate solution that suits the client. This may be a proprietary product that the advisor is only able to sell based on company and contract affiliation, licensing and compensation structure. In other words (and these are my words only) the advisor rationalizes the reason for the recommendation whether or not it’s in the client’s best interest.

Proponents of the suitability standard are normally compensated by commissions only or a combination of commission and fees. They are normally adamant about only adhering to the suitability standard. Why? The answer is simple: self-preservation. Think of it this way, if the only way you’re compensated is through the sales of a product then why would you want to be held to a standard that says what you’re selling has to be in the best interest of the client? What if you can only sell life insurance or annuities? As the saying goes, if you all you have is a hammer then everything looks like a nail.

Proponents of the fiduciary standard are dominantly compensated by fees directly from the client. What does this mean? This means the client pays the advisor for their advice, not a product sale. The relationship nor the compensation of the advisor isn’t tied to a sale it’s tied to the quality of advice. In other words, it’s very transparent. The client knows exactly what they’re paying for and can rest assured they’re getting advice regardless of a product sale. In this case the advisor has a tool box full of tools to utilize instead of just one tool.

Admittedly this type of system is not 100% perfect. There will still be a few bad apples and there will always be outliers, and there will be bad advice. However, from personal experience I have been able to witness both sides. Early in my financial career I worked for a firm that was commission only – one of those firms where I was told if the client wasn’t going to buy, send them to the 800 number. Really. Temptation to sell something, anything to make a living was high. I was arguably the worst salesperson they had. It’s extremely difficult to be a fiduciary in that situation – not impossible, but difficult.

Being able to work with a firm that is aligned with my own beliefs embracing the fiduciary standard there is zero temptation to recommend anything less than what’s best for the client. No sales pressure, no product pushing.

For those that would argue against the fiduciary standard let me ask this question. It’s a question I ask ask frequently of my students and colleagues that argue in favor of suitability.

“If roles were reversed and you were the client, what standard would you want applied to you?”

They answer almost always the fiduciary standard. The next question is rhetorical, but apt:

“They why should your clients get anything less than what you want for yourself?”

There’s usually silence.

Posted on Apr 18th, 2014

by author: sraskie.

Posted in: fee-only, fiduciary, financial planning.
Tagged: fiduciary · financial planning

Obamacare and Your 2013 Tax Return

Apr 14th, 2014

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Taxation – Highlighted in the dictionary (Photo credit: efile989)

So – you’re considering your income tax return (or maybe you’ve already filed) and you’re wondering if there are things you need to know with regard to Obamacare. Fortunately, it’s not much (for most folks), for your 2013 return anyhow. Next year will be a different story.

The IRS recently produced their Health Care Tax Tip HCTT-2014-10 which lists some tips about how the health care law impacts your 2013 tax return. The actual text of the Tip is below:

What do I need to know about the Health Care Law for my 2013 Tax Return?

For most people, the Affordable Care Act has no effect on their 2013 federal income tax return. For example, you will not report health care coverage under the individual shared responsibility provision or claim the premium tax credit until you file your 2014 return in 2015.

However, for some people, a few provisions may affect your 2013 tax return, such as increases in the itemized medical deduction threshold, the additional Medicare tax and the net investment income tax.

Here are some additional tips:

Filing Requirement: If you do not have a tax filing requirement, you do not need to file a 2013 federal tax return to establish eligibility or qualify for financial assistance, including advance payments of the premium tax credit to purchase health insurance coverage through a Health Insurance Marketplace. Learn more at www.Healthcare.gov.

W-2 Reporting of Employer Coverage: The value of health care coverage reported by your employer in box 12 and identified by Code DD on your Form W-2 is not taxable.

Information available about other tax provisions in the health care law: More information is available on www.IRS.gov regarding the following tax provisions: Premium Rebate for Medical Loss Ratio, Health Flexible Spending Arrangements, and Health Saving Accounts.

More Information

Find out more tax-related provisions of the health care law at www.IRS.gov/aca.

Find out more about the Health Insurance Marketplace at www.Healthcare.gov.

Posted on Apr 14th, 2014

by author: jblankenship.

Posted in: #noTOP, Affordable Care Act, income tax, irs, Obamacare.
Tagged: Affordable Care Act · income tax · Obamacare

The Cost of Waiting

Apr 11th, 2014

by sraskie.

3 comments

Procrastination is a silent and slow killer. Everyone, including yours truly, is guilty of putting things off, waiting until the last minute and then scurrying around frantically to get done what we could have easily gotten finished weeks or months ago if we would have either planned ahead or simply started.

Let me give you an example. Last year my wife and I were debating whether or not to have a tree removed from our back yard. The culprit is the much loathed sweet gum tree that is common in this area of the country. Readers familiar with this pariah of the deciduous family of trees recognize it with annoying “gumballs” that are far from being smooth but rather are the sharp and pointy fruits that fall relentlessly from the tree mainly in the fall and work wonders on mower blades and bare feet. Needless to say they are a pain – good only for the occasional “Darn it!” (My kids are within earshot).

Tired of raking and tripping over them we got an estimate to have the tree removed. Balking at the price, we waited. A year later we decided to have it removed for sure. This year’s estimate was much higher than last. Crud. If only we hadn’t waited…

Naturally this story can be related to financial planning – appropriate in many situations but perhaps mostly apt when it comes to saving for retirement. What is the true cost of waiting? Planners and savers alike have probably seen scenarios or illustrations that depict what happens if someone starts saving for retirement at say age 21 versus someone who waits and doesn’t start until a later age.

Let’s look at an example. To be fair, this example will use an average rate of return over a number of years. As we know the market is hardly consistently average but it helps explain the cost of waiting.

Jane, age 21 and a college senior wakes between naps in class and actually listens to her personal finance professor and opens an IRA and starts contributing $2,000 annually (a slight ribbing to my student readers – of which there may be zero!). Jane consistently saves $2,000 annually for the next 40 years and makes a modest 4% rate of return over her working life until age 61. After 40 years she’s acquired a nice sum of $190,051.

John, also the same age decides to wait and says he’ll start saving when he “can afford to”. John finally realizes he needs to start saving at age 41. Thinking he’s smarter than most he decides to play catch-up and “doubles down” on his savings payment over Jane’s. He saves $4,000 per year for the next 20 years. Again assuming a 4% return over 20 years John’s IRA reaches a respectable $119,112 but roughly $70,000 less than Jane. If only John knew that he could save less annually by starting early and have more in the end.

His cost of waiting: $70,000.

Trees and IRAs aside, the cost of waiting can be seen in many aspects of our lives. I am not saying that we need to rush to judgment, but I am saying that procrastination is bad when we know we need to act and feel guilty if we don’t. So what are you waiting for?

Posted on Apr 11th, 2014

by author: sraskie.

3 comments already - add to the conversation!

Posted in: financial planning, IRA, ira account, iras, saving.
Tagged: fiduciary · financial planning · IRA · ira account · retirement savings

Avoiding Mistakes on Your Tax Return

Apr 10th, 2014

1 comment

189px-YOU_ARE_ONE_-_NARA_-_516201 When filing your tax return you want to make sure that you don’t make mistakes. Mistakes can be costly in terms of additional tax and penalties, as well as the extra time and grief they can cause you. Most of the time using e-filing software can help you to avoid these mistakes, but you should check over the return anyhow to make certain you haven’t fat-fingered something or if something didn’t go wrong with the software.

The IRS recently issued their Tax Tip 2014-46, which lists out 8 common mistakes that folks make on their tax return, and how to avoid them where possible. The actual text of the Tip follows below:

Eight Common Tax Mistakes to Avoid

We all make mistakes. But if you make a mistake on your tax return, the IRS may need to contact you to correct it. That will delay your refund.

You can avoid most tax return errors by using IRS e-file. People who do their taxes on paper are about 20 times more likely to make an error than e-filers. IRS e-file is the most accurate way to file your tax return.

Here are eight common tax-filing errors to avoid:

Wrong or missing Social Security numbers. Be sure you enter all SSNs on your tax return exactly as they are on the Social Security cards.
Wrong names. Be sure that you spell the names of everyone on your tax return exactly as they are on the Social Security cards.
Filing status errors. Some people use the wrong filing status, such as Head of Household instead of Single. The Interactive Tax Assistant on www.IRS.gov can help you choose the right one. Tax software helps e-filers choose.
Math mistakes. Double-check your math. For example, be careful when you add or subtract or figure items on a form or worksheet. Tax preparation software does all the math for e-filers.
Errors in figuring credits or deductions. Many filers make mistakes figuring their Earned Income Credit, Child and Dependent Care Credit, and the standard deduction. If you’re not e-filing, follow the instructions carefully when figuring credits and deductions. For example, if you’re age 65 or older or blind, be sure you claim the correct, higher standard deduction.
Wrong bank account numbers. You should choose to get your refund by direct deposit. But it’s important that you use the right bank and account numbers on your return. The fastest and safest way to get a tax refund is to combine e-file with direct deposit.
Forms not signed or dated. An unsigned tax return is like an unsigned check – it’s not valid. Remember that both spouses must sign a joint return.
Electronic filing PIN errors. When you e-file, you sign your return electronically with a Personal Identification Number. If you know last year’s e-file PIN, you can use that. If not, you’ll need to enter the Adjusted Gross Income from your originally-filed 2012 federal tax return. Don’t use the AGI amount from an amended 2012 return or a 2012 return that the IRS corrected.

Posted on Apr 10th, 2014

by author: jblankenship.

Posted in: income tax, irs.
Tagged: income tax · irs

Capital Gains and Losses and Your Tax Return

Apr 9th, 2014

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AlistairDarling (Photo credit: StCartmail)

When you own certain kinds of assets and you sell them, you may incur a capital gain or loss that is applicable to your income tax preparation. If the original purchase price plus applicable expenses associated with the asset (known as the basis) is less than the proceeds that you receive from the sale of the asset, you have incurred a capital gain. On the other hand, if the basis of your asset is greater than the proceeds from the sale, you have incurred a capital loss.

Capital gains are taxable to you, using a separate tax rate – and capital losses can be deducted from your capital gains for the year. Excess capital losses (above your capital gains for the year) can be used to reduce your income by up to $3,000 per year, carried forward until used up (or for your lifetime).

The IRS recently produced their Tax Tip 2014-27 which lists ten facts about capital gains and losses that you may find useful as you prepare your tax return. The text of the actual Tip is below:

Ten Facts about Capital Gains and Losses

When you sell a ‘capital asset,’ the sale usually results in a capital gain or loss. A ‘capital asset’ includes most property you own and use for personal or investment purposes. Here are 10 facts from the IRS on capital gains and losses:

Capital assets include property such as your home or car. They also include investment property such as stocks and bonds.
A capital gain or loss is the difference between your basis and the amount you get when you sell an asset. Your basis is usually what you paid for the asset.
You must include all capital gains in your income. Beginning in 2013, you may be subject to the Net Investment Income Tax. The NIIT applies at a rate of 3.8% to certain net investment income of individuals, estates, and trusts that have income above statutory threshold amounts. For details see www.IRS.gov/aca.
You can deduct capital losses on the sale of investment property. You can’t deduct losses on the sale of personal-use property.
Capital gains and losses are either long-term or short-term, depending on how long you held the property. If you held the property for more than one year, your gain or loss is long-term. If you held it one year or less, the gain or loss is short-term.
If your long-term gains are more than your long-term losses, the difference between the two is a net long-term capital gain. If your net long-term capital gain is more than your short-term capital loss, you have a ‘net capital gain’.
The tax rates that apply to net capital gains will usually depend on your income. For lower-income individuals, the rate may be zero percent on some or all of their net capital gains. In 2013, the maximum net capital gain tax rate increased from 15 to 20 percent. A 25 or 28 percent tax rate can also apply to special types of net capital gains.
If your capital losses are more than your capital gains, you can deduct the difference as a loss on your tax return. This loss is limited to $3,000 per year, or $1,500 if you are married and file a separate tax return.
If your total net capital loss is more than the limit you can deduct, you can carry over the losses you are not able to deduct to next year’s tax return. You will treat those losses as if they happened that year.
You must file Form 8949, Sales and Other Dispositions of Capital Assets, with your federal tax return to report your gains and losses. You also need to file Schedule D, Capital Gains and Losses with your return.

For more information about this topic, see the Schedule D instructions and Publication 550, Investment Income and Expenses. They’re both available on www.IRS.gov or by calling 800-TAX-FORM (800-829-3676).

Posted on Apr 9th, 2014

by author: jblankenship.

Posted in: capital gains and losses, income tax, investing, investment, irs.
Tagged: capital gains and losses · investment

Simplified Home-Office Deduction Available

Apr 7th, 2014

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home office (Photo credit: Sean MacEntee)

Beginning with your 2013 tax return you have a new option available for calculating the Home-Office deduction – based solely on the square footage of the dedicated space used for the home office.

Instead of having to maintain records that are directly and indirectly associated with your home office, you can use the simplified method, which applies a flat $5 rate per square foot to the home office space, up to a maximum of $1,500.

The record-keeping and tax preparation simplification is very beneficial: Form 8829 (the usual home-office deduction form) can cause a lot of headaches to prepare, especially if you have more than one home office and you itemize your home mortgage interest and real estate taxes. For a single home office your tax preparation software will do much of the work for you, but complications like a second home office (not that uncommon in these days of officing-at-home) it can be complex.

Unfortunately, in my experience working with tax returns so far this season, it seems that the simplified method often results in a smaller home-office deduction than the old method. With the simplified method you get the option to deduct your full real estate taxes and home mortgage interest above and beyond the home office deduction, whereas the old method required you to apportion these expenses between business and personal. If the new method appeals to you, it is much simpler than gathering all the records and figuring out how to correctly fill out the forms.

The IRS recently issued their a news release, IR-2014-24, which details information about the simplified deduction.

Reminder To Home-Based Businesses: Simplified Option for Claiming Home Office Deduction Now Available; May Deduct up to $1,500; Saves 1.6 Million Hours A Year

Washington – The Internal Revenue Service today reminded people with home-based businesses that this year for the first time they can choose a new simplified option for claiming the deduction for business use of a home.

In tax year 2011, the most recent year for which figures are available, some 3.3 million taxpayers claimed deductions for business use of a home (commonly referred to as the home office deduction) totaling nearly $10 million.

The new optional deduction, capped at $1,500 per year based on $5 a square foot for up to 300 square feet, will reduce the paperwork and recordkeeping burden on small businesses by an estimated 1.6 million hours annually.

The new options is available starting with the 2013 return taxpayers are filing now. Normally, home-based businesses are required to fill out a 43-line form (Form 8829) often with complex calculations of allocated expenses, depreciation and carryovers of unused deductions. Instead, taxpayers claiming the optional deduction need only complete a short worksheet in the tax instructions and enter the result on their return. Self-employed individuals claim eht home office deduction on Schedule C Line 30, farmers claim it on Schedule F Line 32, and eligible employees claim it on Schedule A Line 21.

Though some homeowners using the new option cannot depreciate the portion of their home used in a trade or business, they can claim allowable mortgage interest, real estate taxes and casualty losses on the home as itemized deductions on Schedule A. These deductions need not be allocated between personal and business use, as is required under the regular method.

Business expenses unrelated to the home, such as advertising, supplies and wages paid to employees, are still fully deductible.

Long-standing restrictions on the home office deduction, such as the requirement that a home office be used regularly and exclusively for business and the limit tied to the income derived from the particular business, still apply under the new option.

Further details on the home office deduction and the new option can be found in Publication 587, posted on www.IRS.gov.

Posted on Apr 7th, 2014

by author: jblankenship.

Posted in: deductions, home office, income tax, irs.
Tagged: deductions · income tax · irs

Should You Pay Off Your Mortgage Early?

Apr 4th, 2014

by sraskie.

12 comments

As individuals pursue the American Dream of buying their first or next home the question may arise on whether or not it’s a good idea to pay down the mortgage and have no mortgage debt or pay the normal monthly payment and invest the extra money that would have gone to pay down the mortgage early in a place (the stock market) that offers the potential for higher returns over the long run.

There are many fierce advocates for paying off debt, any debt early. While this is a wise choice regarding high interest debts such as credit cards, student loans and other high interest loans it may not necessarily be the case for home mortgage debt.

Here’s a situation where for some folks it may make sense to pay down early and for others they may wish to consider invested the extra money elsewhere.

Generally, the younger a person or couple is when owning the home and the lower the interest rate on the mortgage it may make sense to forgo the extra payments to the mortgage and invest the money for potential greater returns on the market. With lower interest rates and the potential deductibility of the home mortgage interest the return on paying down the mortgage early may not be as great as long term gains in the market.

On the other hand, for an older couple nearing retirement they may consider paying down the mortgage early and owning their home free and clear when entering retirement. The emotional satisfaction of not having that expense in retirement and being able to take their former house payment and use that money elsewhere can bring great satisfaction. Since the couple has less time to accumulate wealth via the market, they can possibly achieve a greater return by paying off their home.

Another situation to consider is if there’s a need or a want for a safe, guaranteed return on someone’s money. Paying off debt early is an excellent way to achieve these types of returns. For example, if a couple has a 3.5% interest rate on their home and they have 15 years left on their mortgage, by paying off the home mortgage early they can achieve 3.5% returns, guaranteed, by eliminating that debt as soon as possible.

The trade-off here is they may miss out on potential gains in the market that may supersede the 3.5% return on paying off the debt. Again, this is a judgment call based on someone’s desire to get a guaranteed return or completely eliminate their debt.

So the answer is that it really depends on a person’s goals, situation and appetite for debt and risk. Home debt isn’t bad (we are not considering being upside down on a mortgage or buying a home that can’t be afforded). It’s simply a way to own a piece of the American Dream and the choice to pay down the mortgage early is a matter of judgment.

Posted on Apr 4th, 2014

by author: sraskie.

12 comments already - add to the conversation!

Posted in: fee-only, fiduciary, financial planning, first time homebuyer credit, itemized deduction, itemized deductions, mortgage, mortgage debt, remortgage.
Tagged: fiduciary · financial planning

Further Guidance on the One-Rollover-Per-Year Rule for IRAs

Apr 2nd, 2014

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As a follow-up to the recent post on this blog The One-Rollover-Per-Year Rule: Revised, the IRS has recently released some additional guidance on the subject, via Announcement 2014-15.

As previously mentioned, the IRS has determined to begin using the one-rollover-per-year rule applied to ALL IRAs that the taxpayer owns, rather than only the affected IRAs that have been involved in a rollover.

According to the Announcement, the IRS fully acknowledges that the previous understanding of the rule was that it applied on an IRA-by-IRA basis. In fact, there was a Proposed Regulation § 1.408-4(b)(4)(ii) on the books that was to further define the rule as applied only to the involved IRAs. Ever since the Tax Court decided otherwise in the case Bobrow v. Commissioner (TC Memo 2014-21), the rule has been changed.

According to the recent announcement though, this will not take affect across the board until January 1, 2015. Prior to that date, presumably, the old interpretation will be used, except, apparently, for Mr. Bobrow’s case (and any further cases that might be tried by the Tax Court).

Posted on Apr 2nd, 2014

by author: jblankenship.

Posted in: IRA, irs.
Tagged: IRA · irs

File and Suspend in the Crosshairs?

Mar 31st, 2014

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Image courtesy of chanpipat at FreeDigitalPhotos.net

Note: with the passage of the Bipartisan Budget Act of 2015 into law, File & Suspend and Restricted Application have been effectively eliminated for anyone born in 1954 or later. If born before 1954 there are some options still available, but these are limited as well. Please see the article The Death of File & Suspend and Restricted Application for more details.

Apparently in the President’s recent budget documentation there is a brief mention of a desire to curtail the availability of File and Suspend as an option for Social Security benefit filing.

The reason, it appears, is that the Obama administration views this option as one used only by high income folks to take advantage of the government with this valuable option.

The problem with that viewpoint is that it is used by folks of all income levels, and in fact if it is taken away this could cause some big problems for folks who can least afford to lose benefits. As if anyone can afford to lose benefits, right?

Here’s what happens with File and Suspend: a Social Security benefit recipient has a spouse and/or children that would be eligible for benefits based on his or her record when he or she files for benefits. If he or she happens to be at or older than Full Retirement Age (FRA, age 66 for folks born before 1955, up to age 67 for folks born in 1960), he or she can file and immediately suspend his or her own benefits, allowing his or her spouse or young children to receive benefits immediately. By suspending his or her own benefit, he or she will earn delayed retirement credits of 8% per year, which will later provide him or her with an enhanced retirement benefit.

This is exactly the same outcome for the spouse and dependents that would play out if the benefit recipient was to file and *not* suspend benefits – and actuarially the end result should be the same for the primary benefit recipient as well. Where use of File and Suspend makes a big difference is much later. In the event of the recipient’s untimely early death, the spouse will receive a much enhanced survivor benefit. And if the recipient lives a long, healthy life, he or she will enjoy the enhanced benefit as well.

I can’t see where this is an issue of higher income versus lower income, as has been reported. I believe that the File and Suspend option is being unfairly vilified without complete understanding. The fact that folks with higher incomes have been more likely to choose File and Suspend as an option shouldn’t be cause to eliminate the option for everyone. As I mentioned, actuarially this should have little or no effect.

The likely reason that higher income folks have been more likely to choose this option is because higher income folks are more likely to seek guidance when filing for Social Security benefits – but again, the word is getting out about this option and more folks are choosing it (once they talk the SSA folks into understanding it!).

As well, often folks with lower incomes and future Social Security benefits may not be in a position to delay receipt of benefits, making File and Suspend a good idea but not viable.

I hope that this gets dropped. Doing away with File and Suspend will have no beneficial impact on the future viability of the Social Security system, in my opinion. All this is likely to do is make a lot of software developers rewrite their software to remove this option. If looking for provisions to remove in order to make the system a bit more cost-effective, perhaps the restricted application should be considered. This one may actually cost the system a bit extra, but so few people even know about it that it’s unlikely.

The real answer is to either re-do the overall calculations, put in place more effective means testing, and/or change the tax structure, perhaps to include all earned income instead of the capped income as the system works now. Until we face these factors and make real changes, we’re likely to continue on the path to unsustainability within the Social Security system.

Posted on Mar 31st, 2014

by author: jblankenship.

Posted in: #noTOP, file and suspend, Social Security, Social Security spousal benefit.
Tagged: file and suspend · social security administration · social security spousal benefits

A Bad Day or a Bad Life?

Mar 28th, 2014

by sraskie.

4 comments

As a financial planner I am often asked whether or not a personal liability umbrella policy is worth the price. Generally, my answer is a resounding “Yes!”

Personal liability umbrella policies or PLUPs (for the remainder of this article) are insurance policies that provide coverage above and beyond the underlying liability limits on an individual’s or family’s auto insurance or home owners insurance. PLUPs can also be purchased by folks that have renters insurance or condo insurance policies. PLUPs are usually purchased in $1 million limits starting at $1 million.

Umbrella policies work like this: Generally the person applying for the PLUP has their auto and or home insurance with the insurance company they are considering purchasing the PLUP through. What the insurance company will do is require that in the underlying auto policy that the personal liability (if a member of the insured household is liable for damages in an auto accident) of the policy be at least a specific amount – often $250,000 or higher.

Likewise with the home policy; the insurance company will require the liability coverage of the home be at least a certain amount – often $300,000 or higher. These amounts must be exhausted first before the PLUP will pay.

Should the insured be liable in an auto accident or accident at the home (trample injuries or pool incidences are common) the insurance company will pay from the auto or home policy first and any damages left over are then recovered from the umbrella policy. Liability in an auto accident or home accident cannot be interchanged (you can’t use home liability for an auto accident and vice versa).

Let’s look at an example. Suppose Danny was driving his car and crossed the center line and hit another car head on. All three passengers in the other car sustained serious injuries totaling $750,000. Danny’s auto policy is set up where it pays $250,000 of bodily injury per person and $500,000 total per accident. Assuming each person sustained $250,000 in damages, Danny’s policy would cover $500,00 of the damages and essentially ‘run out’ of money. If Danny doesn’t have an umbrella – he’s responsible for the remaining $250,000.

Luckily, Danny purchased a PLUP. With $1 million in umbrella coverage the umbrella takes care of the remaining $250,000 Danny is liable for – including any legal defense. Here Danny only had a bad day.

If Danny didn’t have the PLUP – he is subject to wage garnishment, seizure of assets, etc. until he pays what he owes. In other words, he’s got a bad life.

PLUPs may also cover liability in the event someone is liable but the act wasn’t caused while using the auto or home policies. Typically the PLUP will pay after the insured pays a self-insured retention (deductible) which may be anywhere from $1,000 to $5,000.

PLUPs are pretty reasonably priced and will fluctuate based on a number of factors. For example, a single person with one car, one home, no moving violations or at-fault accidents will pay a pretty cheap premium – about $150-$200 annually. A couple with two cars, a home, boat, ATVs, and teenage drivers will pay much more since there is more risk with the vehicles and teen drivers. They may be looking at $500-$750 annually. The premium will fluctuate according to the risk exposure.

Why are PLUPs generally so cheap? It’s because the underlying insurance requirement on the policies under the “umbrella” must be high. It’s rare that these higher amounts are exceeded and umbrellas are used. Insurance companies know that due to the low percentage of PLUPs that pay that PLUPs are cash cows for them and they can price them reasonably for their clients.

Are PLUPs a good idea? Yes. In the event that the worst happens, would you rather have a bad day or a bad life?

Posted on Mar 28th, 2014

by author: sraskie.

4 comments already - add to the conversation!

Posted in: Insurance, Personal liability umbrella, PLUP, umbrella insurance.
Tagged: financial planning

How Does an Early Withdrawal from a Retirement Plan Affect My Taxes?

Mar 26th, 2014

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Image courtesy of adamr at FreeDigitalPhotos.net

Oftentimes we are faced with difficult situations in life – where we need extra money to pay for a major car repair, a new roof for the house, or just day-to-day living expenses – and our emergency funds are all tapped out. Now your options become poor: should I go to a payday loan place, put more on my credit card? My mortgage is upside-down so there’s no home equity loan in my future, and I can’t ask my folks for a loan, I’ve asked them for too much. Hey, what about my retirement plan? I’ve got some money socked away in an IRA that’s just sitting there, why don’t I take that money?

It’s really tough to be in a situation like this, but you need to understand the impacts that you’ll face if you decide to go the route of the IRA withdrawal, especially if you’re under age 59½.

Any money that you take out of a retirement plan as a withdrawal will be taxed as ordinary income – just like wages, salaries, and tips. So if you’re in the 25% marginal tax bracket, every dollar that you withdraw from your IRA or 401(k) plan (if allowed) will cost you 25 cents right off the top.

In addition to the ordinary income tax, if you’re less than 59½ years of age you’ll also be hit with an additional 10% penalty for an early withdrawal (unless your withdrawal meets one of these 19 exceptions). So now every dollar that you withdraw costs an extra 10 cents on top of the ordinary income tax. If you’re in the 25% bracket, that $10,000 withdrawal from your IRA can cost you as much as $3,500 in extra taxes and penalties.

Bear in mind that you may be able to take a temporary loan from your 401(k) or other qualified retirement plan (QRP) if you’re still employed by that employer. Naturally you’ll need to repay the loan, but it might be a better option cost-wise than the other choices. Plus, if you have an outstanding loan from your QRP and you leave the employer you’ll be required to either recognize the balance of the loan as a withdrawal or pay it back to the plan immediately.

Armed with this information makes your decision points much more clear: review all of the available options mentioned above (loans from family and friends, home equity loans, payday loans, and the like) against the cost of the taxes for taking an early withdrawal from your retirement plan. The best option may be to see about a formal loan from family, paying them a reasonable rate of interest. But of course, your circumstances are going to dictate the best option for you. Just go into it with your eyes wide open.

Posted on Mar 26th, 2014

by author: jblankenship.

Posted in: Early Distribution, IRA, qrp.
Tagged: early distribution · IRA · qrp

Can You Itemize? Or, Should You Itemize?

Mar 24th, 2014

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Image courtesy of Stuart Miles at FreeDigitalPhotos.net

When you prepare your taxes each year, you’re faced with a decision – itemize deductions or take the standard deduction? Most of the time it’s not a question of whether you can itemize, but rather should you itemize.

Most Anyone Can Itemize…

This is due to the fact that most anyone can itemize. If you’ve paid state and/or local income or sales taxes, real estate taxes, or paid mortgage interest, you have deductions to itemize. Same goes for charitable contributions. All of these items that you’ve paid out are eligible to be deducted on Schedule A of your tax return, without a lower limit.

If you have medical expenses, these can be deductible if the total of your medical expenses are more than 10% of your Adjusted Gross Income (AGI). For 2013 tax returns, if you’re 65 years of age or older, your medical expenses that are more than 7.5% of your AGI will be deductible.

In addition, certain job expenses and other miscellaneous expenses, such as tax preparation expenses, safe deposit box rental, and the like, can be deductible to the extent that they exceed 2% of your AGI.

If you’ve paid out any of these expenses during the tax year, you can itemize. That doesn’t mean that you should itemize, though.

… But Should You Itemize?

So you’ve determined that you have deductible expenses and you can itemize – let’s look at reasons why you should itemize.

The initial answer is really rather simple – if the total of all the deductible items that you’ve found to put on your Schedule A is greater than your applicable Standard Deduction, then you probably should itemize. The Standard Deduction is based upon your Filing Status (2013 figures):

Filing Status	Standard Deduction	Over Age 65 or Blind, per Person
Single	$6,100	+ $1,500
Married Filing Jointly	$12,200	+ $1,200
Head of Household	$8,950	+ $1,500
Married Filing Separately*	$6,100	+ $1,200
Qualifying Widow(er)	$12,200	+ $1,200

If someone else claims you as a dependent on his or her tax return, your Standard Deduction is the lesser of $1,000 or earned income plus $350, up to the normal Standard Deduction for your filing status.

If your deductions amount to less than the Standard Deduction for your filing status, don’t despair. It’s not as if being able to itemize your deductions is some sort of bonus – it’s actually the other way around. You see, if you have more deductions when itemizing than the Standard Deduction, that means you had to pay out that money during the year. On the other hand, if you had fewer itemized deductions (or no deductions to itemize), you’re getting to reduce your taxable income by the Standard Deduction without having to pay out that money!

Now there is at least one circumstance when you’re required to itemize your deductions, and we’ll cover that next.

Or, Do You Have to Itemize?

*If you and your spouse file separate returns with filing status of Married Filing Separately and your spouse itemizes deductions on Schedule A, you are also required to itemize your deductions on Schedule A, or take a Standard Deduction of $0.

Wrapping it up

You can always choose to itemize your deductions even if they are less than the Standard Deduction for your filing status. You only need to mark the box on Line 30 of Schedule A. You might want to do this if it would somehow benefit your state income tax, for example.

Lastly – the only way to itemize deductions is by also filing your tax return on Form 1040. If you choose to use either Form 1040A or Form 1040EZ, you are not eligible to itemize your deductions. If you use tax return preparation software (or your qualified preparer does) the decision will be made for you, more than likely.

Posted on Mar 24th, 2014

by author: jblankenship.

Posted in: income tax, irs, itemized deductions.
Tagged: itemized deductions · standard deductions

How To Save (and Pay) for College

Mar 21st, 2014

by sraskie.

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Saving for college is a priority among many parents. Often we are asked about the right savings vehicle for college education. There are a few that parents can choose from between Coverdell ESAs, prepaid tuition and 529 college savings savings plans.

We’ll discuss the 529 plan here. The 529 plan is essentially a college savings vehicle very similar to an IRA or an employer-sponsored plan. Depending on the state you live in your state may have a 529 plan that will have access to stock and bond mutual funds and or a pre-determined mix that will invest the money and allocate it for you depending on your risk tolerance or your time horizon upon entering college.

Many states such as Illinois well even offer a state tax deduction for any contributions that you make up to a certain dollar limit. The beauty of 529 savings plans is that there is no income phase out so parents who make quite a bit of money can still contribute.

For grandparents wanting to put their grandkids through school or help pay for college a 529 can be an excellent way to help do that as well as reduced their estate. For 2014, a person can gift up to $14,000 to a 529 savings plan and couples who elect to split gifts can contribute $28,000 for one individual (529 beneficiary). This can be done for multiple beneficiaries that each have a 529 plan.

For couples who want to make an even bigger contribution they are allowed to make a five-year pro-rata contribution to a 529 savings plan. For a single person this means contributing up to $70,000 at one time without incurring any gift tax consequences and for a married couple contributing up to $140,000 at one time based on this special five year pro-rata rule. Once this is done another gift cannot be made until the five year period is over. The process can be repeated again for another 5 year pro-rata period.

From an estate planning perspective once the 5 years is up, the gifted money is removed from the estate.

Money contributed to 529 plans grow tax deferred and qualified withdrawals from the 529 for education expenses are then tax free. Withdrawals not used for expenses are subject to ordinary income tax and a 10% penalty.

Another way for a grandparent to remove money from the estate is to make a direct payment for tuition to the college or university the grandchild attends. This direct tuition payment does not count toward the annual exclusion and can be done for any number of grandchildren. Keep in mind that the payment must go for the tuition and directly to the school. If the grandparent pays the grandchild directly, they can use the annual exclusion, but if the tuition is $25,000 and the exclusion is only $14,000 (single) then there may be gift tax consequences.

Posted on Mar 21st, 2014

by author: sraskie.