The highest federal income tax rate is currently 35%. In theory, tax rates could go down, stay the same or go up. Which direction do you think they are going in? The obvious answer is up. When will this happen? Who knows…maybe not for a while. But they will go up. The Government needs the money. It really is just that simple. Why defer income into the future if you think you will be taxed at a higher rate?
To be eligible for a Roth IRA a taxpayer needs to be under age 70 ½ and have earned income. Additionally there is a limitation on their earnings. For a married couple filing a joint return if their modified adjusted gross income is over $183,000 in 2012 they are not eligible for a Roth IRA.
A 401(k) Plan is designed to create tax deferred income. Contribute to the plan during your working career and defer the taxes on this until you retire and begin taking distributions. This is fine while you are working and not paying taxes on these earnings. However, when a taxpayer is over age 70 ½ they must begin to take distributions from their 401(k) Plan and IRA which will be taxable income.
The Roth 401(k) Plan has a few similarities to a 401(k) Plan. There is however one huge difference. The Roth 401(k) Plan, like a 401(k) Plan is an employer sponsored plan that allows employees to contribute through payroll withholding. With a Roth 401(k) Plan however the contributions are made after tax. This is the key difference between a Roth 401(k) Plan and a 401(k) Plan. Unlike the Roth IRA, there is no income limitation on a Roth 401(k) Plan.
When a qualified distribution is made from a Roth 401(k) Plan there is no income tax. If there are assets in the Roth 401(k) plan there will need to be distributions starting at age 70 ½. If this is not what is wanted, the assets should be rolled into a Roth IRA and there will be no required distribution at age 70 ½ for a taxpayer or their surviving spouse like there is with a 401(k) Plan or an IRA.
ACTION ITEM: High income earners should consider the benefits of participating in their employers Roth 401(k) Plan.
Thomas F. Scanlon, CPA, CFP®
Source: IRS Code
The information in this report does not purport to be a complete description of the securities, markets or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Any opinions are those of Thomas F. Scanlon, CPA, CFP® and not necessarily those of RJFS or Raymond James. Non-qualified withdrawals prior to age 59 and ½ may be subject to a 10% penalty. Tax laws are subject to future revisions. Raymond James does not offer tax advice. Please consult a tax advisor for any tax related issues.
A Financial Plan can provide a road map for where you want to go. One of the biggest challenges can be with addressing taxes. Here are 6 Taxes That Can Damage Your Financial Plan:
1) Federal Income Tax- The federal income tax is assessed with graduated tax brackets. Currently the highest ordinary income tax bracket is 35%.
2) Alternative Minimum Tax- The Alternative Minimum Tax (“AMT”) has been getting a lot more press recently. This is a nasty back door tax that can catch taxpayers by surprise. Taxpayers must calculate their tax under the regular method and then under the AMT method. Then the pay the higher of the two taxes. The stated rate of the AMT can be either 26% or 28%.
3) Capital Gains Tax- The Capital Gains Tax is a hot button thanks to Mitt Romney recently releasing his income tax returns. Long term capital gains are generally taxed at 15%. Short term capital gains are taxes as ordinary income.
4) State Income Tax- Most states have an income tax. Connecticut recently increased their income tax rate substantially on higher income earners.
5) Social Security and Medicare Tax- This tax is assessed against earned income. The social security tax is 6.2% on up to $110,100 in 2012. The Medicare tax is 1.45% on all earned income. Employers must match these amounts. For the self-employed they are treated as both the employer and employee and pay both of these taxes twice. The social security tax is 12.4% on their first $110,000 of earnings and their Medicare tax is 2.9% on all of their earnings.
6) Estate Tax- Many investors have taken their eye off of estate taxes. Recent legislation has made the federal estate tax exclusion $5.2 million dollars. If a married couple uses a Credit Shelter Trust, they can exclude twice this amount or $10.4 million dollars. While many investors may no longer be subject to a federal estate tax, they may still have a state estate or inheritance tax.
ACTION ITEM: Affluent investors need to be aware of these taxes and the damage it can inflict on their financial plan and net-worth.
Thomas F. Scanlon, CPA, CFP®
Source: IRS Code
The information contained in this report does not purport to be a complete description of the securities, markets or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Please note, changes in tax laws may occur at any time and could have a substantial impact upon each person's situation. While we are familiar with the tax provisions of the issues presented herein: as Financial Advisors of RJFS, we are not qualified to render advise on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.
Know Your Goals
Every investor needs to know their goals. This may sound easy to say but perhaps a bit more challenging to really understand. What are your primary investment (life) goals? Do you want to retire by a certain age? Do you want your children to attend college and not have any student loans when they get out? Perhaps it’s to buy a second home down at the shore. Whatever it is, your goals need to be written down. Otherwise, they are just dreams. Dreams are fine, but to make your dreams a reality, write them down. By having your goals written down and then periodically checking in with them, this will assure you stay on track. Remember, your goals will likely change over time. When you accomplish some of your goals, celebrate! Then move on to your next goal.
Know Your Biggest Risks
Every investor faces risks. Some are obvious…like premature death or long-term disability. Other risks may occur to your property such as flood or hurricane damage to your home. One of the larger risks now facing many investors is the risk of running out of money. This is a very real risk. It is important that investors understand what their biggest risks are and take appropriate steps to protect themselves against them. Life, disability, property and umbrella insurance policies are some of the tools used. Find a good insurance agent and work with them closely. Building up your net-worth and seeing it all evaporate because the necessary coverage was not in place is insane.
Know Your Annual Living Expenses
How much does it cost you a year to live? Don’t know this number? Well, it’s time to go through your checkbook and bank statements for the past few months. This should give you a good idea approximately what it costs you to live a year. This number is very important. It will tell you how much (hopefully) you can save every year. If you are not in position to save, then it really is time to analyze your expenses and figure out what you can do without.
Know Your Risk Tolerance
Ah yes, risk tolerance. Everyone seems to have a very high risk tolerance when the stock market is headed up. When stocks are declining, many of these same investors are now “conservative”. Hmmm…sounds like Jekyll and Hyde. The reality is many investors get caught up with two of the more common emotions—greed and fear. Investors become greedy when stocks are rising and fearful when they are falling. It’s natural. You will need to develop the discipline to avoid getting caught up with these emotions.
Know Your Tax Bracket
Every investor needs to know their tax bracket. Why? This will help you decide when to take capital gains and losses, if you should invest in tax-free investments, or fund a Roth IRA instead of a regular IRA. This can be easily done by reviewing your federal and state income tax returns. It’s also important to project what you think your tax bracket will be in retirement.
What can make this analysis somewhat challenging is the Alternative Minimum Tax (“AMT”). There is not enough space (and ink) to address AMT in this newsletter. Suffice to say, if you are paying this tax, you are probably an unhappy camper. If you are not paying this tax, be grateful. The AMT will affect more and more taxpayers every year.
Know Your Investment Strategy
Every investor will need to have a clear investment strategy. This should be something a little more explicit than, “Buy low, sell high.” Unfortunately, many investors get caught up in the latest fad. Remember, with investing, it’s not always about the rate of return. It’s about what your goals are and when will you need the money you are investing now. This puts savers at a huge advantage. Investors that are able to save money are likely putting themselves in a position whereby they may not need to attempt to get a higher rate of return and don’t need to take as much risk. For many investors now, a conservative strategy for them has been to reduce debt. This deleveraging by many individuals has certainly begun to clean up their own balance sheets.
Know Your Estate Plan
The federal estate tax exclusion is currently $5 million. A married couple that sets up their estate plan appropriately can exclude up to $10 million. Mention estate planning and many people roll their eyes and say, “It doesn't’t affect me.” Perhaps, then again, in Connecticut the estate tax exclusion is only $2 million. So, while many may not be subject to federal estate tax, more will be subject to the Connecticut estate tax. For people who are not subject to either tax, the critical issue is….who gets your “stuff” and when do they get it? Therefore, estate planning is for everyone. A basic estate plan would include a will, power of attorney, and a health care proxy. A slightly more advanced plan may include a trust. You have spent a lifetime building your net worth. Don’t you want to have a say in how it is distributed? Also, don’t forget to review all of your beneficiary designation forms for your 401(k) plan, IRA’s, and life insurance.
These are the seven things every investor needs to know. Know and act on these and you will be well on your way with your financial plan.
If you have any questions or need any help with the seven things you need to know, please call me at (860) 645-1515 or e-mail Thomas.Scanlon@Raymondjames.com
Thomas F. Scanlon, CPA, CFP®
The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Thomas F. Scanlon, CPA, CFP® and not necessarily those of RJFS or Raymond James. Expressions of opinion are as of this date and are subject to change without notice. Tax preparation and accounting services are provided by Borgida & Company, P.C., not as a service of Raymond James. You should discuss tax or legal matters with the appropriate professional. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Dividends are not guaranteed and must be authorized by the company’s board of directors. Investments related to a specific sector, where companies engage in business related to a particular industry, are subject to fierce competition, the possibility of products and services being subject to rapid obsolescence and limited diversification.