How to Take Advantage of Your Retirement "Gap Years"

How to Take Advantage of Your Retirement “Gap Years”

Often when I bring up the idea of retirement “gap years” in meetings, my clients’ minds wander toward a family member who’s decided to take a year off between high school and college.  Then they shake their head in disbelief about how millenials are often encouraged to backpack around for a year to mature and “find themselves”.  Another moment of reflection about how the world’s changed, and that’s about when their attention snaps back to refocus on our meeting.

No, retirement gap years don’t have anything do with finding yourself or maturing.  They have to do with the years between retirement and age 70.  Many people will see their taxable income fall to lower levels once they stop working, and spike once they turn 70.  Thus, the retirement income “gap”.

Here’s why.  For those of us with assets in qualified retirement accounts like 401(k) plans or IRAs, 70.5 is the age when the IRS begins imposing mandatory distributions, which will be added to your taxable income.  Once you begin collecting Social Security you’ll also be taxed on either 50% or 85% of the benefits, depending on where that taxable income falls.  If you’re one of the many people waiting until age 70 to collect, that’s two extra sources of taxable income added simultaneously, and recurring every year thereafter.

Thanks to our progressive tax system, the years you find yourself in a lower tax bracket can be a great opportunity to reduce taxes over the rest of your life.  This post will explore how.

How to Take Advantage of Your Retirement "Gap Years"

 

The Opportunity

As you know, we have a progressive tax system here in the U.S.  The higher your taxable income, the higher the rate you pay.  As I write this, the tax brackets for single & married people filing jointly are:

How to Take Advantage of Your Retirement "Gap Years"

Notice the big jumps here – our marginal tax rates don’t increase evenly.  10% & 12%, 22% & 24%, and then 32% and higher.  The increases from 12% to 22%, and again from 24% to 32% are significant, and present a convenient opportunity when planning for retirement.

Think of a typical retirement timeline.  If you plan to stop working at 65 years of age, chances are your taxable income will be higher at age 64 than it will be at age 66.  Then a few years later at age 70.5, you’ll enter RMD territory.  The IRS will force you to take a certain amount of money out of your tax deferred retirement accounts every year, or face a stiff 50% penalty.

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Backdoor Roth Conversion: How to Contribute to a Roth IRA When You Make Too Much Money

Backdoor Roth IRA Conversion: How to Contribute to a Roth IRA When You Make Too Much Money

If you asked me to choose my FAVORITE type of account to invest in, it would definitely be the Roth IRA.  Roth IRAs allow you to save money tax free for the rest of your life.  They’re not subject to mandatory withdrawals in your 70’s, and your kids won’t even owe taxes on their withdrawals if they inherit the account from you down the road.  In my opinion the Roth IRA is just about the best deal out there.

Problem is, they’re not accessible to everyone.  The IRS considers Roth IRAs such a good deal that they won’t let you contribute to one if you make too much money.  Fortunately, there’s a work around: the backdoor Roth IRA conversion.  The backdoor Roth conversion allows you to get money into the Roth IRA by making non-deductible contributions to a traditional IRA.  Don’t worry if this sounds complicated.  We’ll go over the strategy step by step in this post.  Read on to learn more.

 

The Backdoor Roth IRA Conversion Strategy

So here’s how it works.  I’ll break it down into two-distinct steps.  But to start, let’s review the income limitations for direct contributions to a Roth IRA.  If your modified adjusted gross income on the year (MAGI) falls below the “Full Contribution” threshold, you can contribute to a Roth IRA directly.  If your MAGI falls into the phaseout region your contribution limit for the year begins to fall.  When it reaches the “Ineligible” threshold, you’ll be prevented from contributing to a Roth IRA altogether (at least in 2018).  If this is you, the backdoor Roth conversion might be a good fit.  (Here’s a review of how to calculate modified adjusted gross income).

Backdoor Roth Conversion: How to Contribute to a Roth IRA When You Make Too Much Money

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College Tuition Tax Credit: A Consolation Prize to Big Tuition Bills

College Tuition Tax Credit: A Consolation Prize to Big Tuition Bills

If you’re a parent, I’m guessing that at some point you’ve freaked out thought about the cost of your child’s future college tuition.  College costs are rising about 7% per year here in the U.S., and don’t look to be slowing down any time soon.  Most conventional advice we hear about ways to afford college costs has to do with starting to save early, or scouring the earth for potential scholarships.  What many of us forget is that we already have saving opportunities build into our tax code, in the form of a college tuition tax credit.

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Woman Owned Business Tax Benefits: What's Out There?

Woman Owned Business Tax Benefits: What’s Out There?

Several weeks ago I was in a meeting with a small business owner at my office.  She’d come by to talk about her plans to transition away from her business, as she is in her 50’s and getting burnt out.  She’s built a successful enterprise over the years, and stands to make a nice profit on the sale of her equity stake.

Her biggest problem in this transition?  Taxes, of course!  Although she stands to receive a nice chunk of change from the sale, she’ll end up owing several hundred thousands of dollars between state and federal taxes.  And as we worked through the mechanics of the transition and how she might reduce her tax burden, she asked a question I hadn’t thought much about: “aren’t there tax benefits I can claim as a woman owned business?”

I hate to admit this, but woman owned business tax benefits aren’t a subject I’d looked into before.  I’d always assumed there were some tax benefits for women and minority owned businesses, but I’d never looked into what they were exactly.

So I researched it.  And since I’m certain there are thousands of women entrepreneurs out there wondering the same thing, I consolidated my findings into this post.

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Defined Benefits Pension Plan: Helping Business Owners Shelter Thousands from Income Tax

The Defined Benefits Pension Plan: Helping Business Owners Shelter Thousands from Income Tax

Taxes are frustrating to nearly every small business owner I speak with.  Most people agree that we should all pay our fair share.  But after working countless thousands of hours to build a viable business, it’s easy to feel like Uncle Sam’s reaching into our pockets too far.  That’s why I focus on helping my clients who own businesses make sure they’re not paying more in taxes than they need to.  One great tool we can use in this endeavor is a defined benefit retirement plan.  Whatever you want to call it, DB plan, defined benefits pension plan, etc., it can be a killer way to defer a huge portion of your income from taxation.

I realize you might cringe when you read the words “pension” or “defined benefit”.  The idea of promising employees a monthly check throughout their retirement may not foster warm and fuzzies.  But if you don’t have employees, or only have a few, a defined benefit plan can offer some pretty major tax advantages.

Read on to learn how you might take advantage of them.

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Grantor Retained Annuity Trust: An Easy Way for Business Owners to Reduce Wealth Transfer Taxes

Grantor Retained Annuity Trust: An Easy Way for Business Owners to Reduce Wealth Transfer Taxes

For business owners starting to think about the next generation, the phrases”estate tax” or “transfer tax” almost seem like curse words.  The bad news is that when you build an estate of a certain size, the IRS wants to get in your pockets regardless of what, when, or how you transfer your assets to beneficiaries.  The good news is that there are plenty of strategies available to help you minimize these taxes.  The grantor retained annuity trust is one of them, and will be the topic of today’s post.  We’ll cover what they are, why they’re beneficial, and how you might go about using one.

 

 

Gift Tax Review

Ok – before we dive into the details, let’s review what taxes typically apply when you gift an asset to someone else.

First off, you’re allowed to give away $14,000 per year, per person tax free.  If you’re married, you and your spouse are both allowed $14,000 per person per year, or $28,000 total.  So, if you and your spouse want to gift each of your kids $28,000 for their birthday every year, you could do so tax free.  (It’d be one heck of a birthday present, too).

You also have a lifetime gift exclusion.  This is the amount that you can give away, either while you’re alive or after you die, without incurring any federal estate or gift taxes.  Anything that exceeds the $14,000 annual limit (or doesn’t qualify) works against your lifetime exclusion.  The lifetime gift exclusion in 2017 is $5.49 million, which inches higher with inflation over time.  Here again you can combine your lifetime exclusion with your spouse, for a total of $10.98 million.

So let’s say that one year you and your spouse decide to gift your oldest child $128,000.  The first $28,000 would be covered under your annual allowance and excluded from tax.  The remaining $100,000 would work against your lifetime exclusion.  Neither you nor your child would owe tax on the gift, but you’d have worked your lifetime exclusion from $10.98 million down to $10.88 million.  If your future gifts (either while you’re alive or after death) exceed $10.88 million, they’ll be subject to the federal gift/estate tax:

Grantor Retained Annuity Trust: An Easy Way for Business Owners to Reduce Wealth Transfer Taxes

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Using a Section 105 Medical Reimbursement Plan to Reduce Your Tax Bill

Using a Section 105 Medical Reimbursement Plan to Reduce Your Tax Bill

“I paid out the ears in taxes this year.  How can I reduce my tax burden?”

This is a question I’m hearing a lot from business owners recently.  And while it may not sound flashy, the best way to reduce taxes is to incorporate some smart planning into your decision making.  More often than not, business owners simply don’t have the time to research and apply the opportunities offered in the tax code.

So to make your life a little easier, today’s post will cover an often unused tax saving opportunity: the Section 105 medical reimbursement plan.

 

 

An Overview of Section 105 Health Reimbursement Plans

A section 105 health reimbursement plan is a tax-efficient way to repay your employees for their health care costs.  Rather than purchasing group coverage that your qualifying employees can opt into, you allow them to find their own coverage and then reimburse them for qualified expenses.  This can include premiums, deductibles, or a wide variety of other out of pocket costs.  (Side note, there are section 105 plans that combine traditional group coverage with reimbursement for qualified out of pocket costs, but that’s a subject for a future post).

Whereas this would not have been a popular way to offer benefits a decade ago, it’s more palatable now that individual health insurance is widely available through the state and federal marketplaces.

The main benefits of section 105 plans are the tax advantages.  Most small businesses deduct the cost of health insurance premiums for their employees, and possibly for themselves.  But when it comes to their own out of pocket health care costs, business owners normally pay for them with taxable dollars.  These expenses can be deductible at the personal level, but only when they exceed 10% of your adjusted gross income.

With a Section 105 plan you can deduct your entire family’s medical expenses with without being subject to the 10% AGI floor.  Even better, it’s a deduction from income tax at the state and federal levels, AND a deduction from payroll taxes.  For some business owners this can be a savings of thousands of dollars per year.

The tax benefits don’t apply to all types of business entities, though.  S-Corps don’t get to deduct reimbursements through section 105 plans from state or federal income tax.  And if you own a sole prop, a partnership, or an LLC you aren’t considered an employee.  That means you can’t be reimbursed by a plan, and would need to employ your spouse in order to reap the benefits.

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You've Inherited an IRA. Now What?

You’ve Inherited an IRA. Now What?

Inheriting an IRA is quite a bit different than inheriting any other asset.  Unlike cash or investments in a traditional investment account, if you inherit an IRA you’ll need to start withdrawing from the account in order to avoid hefty penalties.  In this post we’ll cover what your options are when you inherit an IRA, and how you can best manage it for you & your family.

 

How IRAs are Passed After Death

Whereas many of your assets will be distributed to heirs according to your will, IRAs are instead distributed by contract. Your custodian (the brokerage firm that holds your account, like Vanguard or TD Ameritrade) lets you designate as many beneficiaries and contingent beneficiaries as you like.  Once you die, your account bypasses your will, the probate process, and is distributed according to this beneficiary designation.

When account holders don’t designate any beneficiaries things get a little murkier.  When the account holder dies, their account is distributed according to their custodian’s default policy.  At most custodians this default policy diverts the IRA back to their estate (and goes through probate) but at some it’s diverted to their spouse first.  Unfortunately, if the account holder didn’t designate a beneficiary while they were alive, you’re at the mercy of your custodian’s policy.

If the account is indeed diverted back to their estate, it’ll be distributed according to your state’s interpretation of their will.  And if they didn’t have one (meaning they died intestate), the state will make its own decision on who should inherit the asset.

The moral of the story?  Take advantage of the opportunity to bypass probate, and designate your beneficiaries formally while you’re still alive.

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How to Hire an Accountant

How to Hire an Accountant

Managing your financial affairs is a big job.  You have to keep track of your income, manage your assets for long term growth, pay taxes, and arrange for your estate to be distributed after you die.

You can do some of these things on your own.  But others, like writing a will, are jobs you’ll probably want to hire a professional for.

Since we’re in the middle of tax season, I thought it might be helpful to cover exactly what to look for when hiring an accountant.  Paying taxes is a fact of life.  But if you can find creative ways to reduce the amount of tax you pay, there will be more left over for you and your family.  It’s for this reason that an accountant is often one of the professionals families hire for money advice.

You can certainly prepare your own taxes if you prefer.  Programs like TurboTax and TaxAct provide quick and affordable ways to compile your financial records and file your taxes.

There is no program that can help you with tax planning, though.  TurboTax and TaxAct are great for tax compliance, where you’re reporting on transactions that’ve already happened.  But if you’d like to know how you might reduce your tax burden in the future, you’ll need some help making decisions on transactions that haven’t happened yet.  This is tax planning, and something that many accountants are very good at.

I covered in a recent post how you can tell whether you need to hire a CPA.  Today’s post will cover how to go about hiring one if you do.

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Top Strategies for Managing Incentive Stock Options

Top Strategies for Managing Incentive Stock Options

Incentive stock options, or ISOs, are a pretty common way for companies to compensate management and key employees.  Otherwise known as “statutory” or “qualified” options, ISOs are a way to give management a stake in the company’s performance without doling out a bunch of cash.

While they can have wonderful tax benefits, far too many people who own ISOs fail to exercise them wisely.  Some estimates even claim that up to 10% of in the money ISOs expire worthless every single year.  If you own incentive stock options but aren’t sure how to manage them, read on.  This post will cover a few of the top management strategies at your disposal.

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