Tax Planning

S3 E4: Understanding the SECURE Act and Inherited IRAs

Understanding the SECURE Act and Inherited IRAs with Megan Gorman

How the SECURE Act May Impact Your Estate Plan with Megan Gorman

In this episode, I interview Megan Gorman, Founder and Managing Partner of Chequers Financial Management, a high-net-worth tax and financial planning firm in San Francisco. An attorney by training, Megan is passionate about the problem-solving required to work in the world of complex financial planning. She is also a senior contributor at Forbes and writes on personal finance and income tax.

As you listen, you won’t be surprised to hear that Megan is an adjunct professor at Golden Gate University in San Francisco as well. She is a very clear communicator and a great educator. And I’m happy to call her a friend, too.

Megan’s expertise is invaluable for today’s topic, inherited IRAs, which is why I’m so excited to have her on the podcast. Specifically, we’re talking about how the SECURE Act of December 2019 changed the rules for certain beneficiaries of inherited IRAs. I think everyone can benefit from this information, whether you have an IRA or expect to inherit one.

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Episode Highlights

  • [08:11] Why the SECURE Act impacts so many people–not just the ultrawealthy
  • [10:28] Two major changes the SECURE Act made to IRAs an how it impacts certain inherited IRA beneficiaries
  • [14:54] Groups of beneficiaries excluded from SECURE Act inherited IRA rules
  • [18:22] Why everyone should take a holistic view of their estate plan in light of these inherited IRA rule changes
  • [24:29] Measures some IRA owners may want to take before they die to reduce their beneficiaries’ tax liability
  • [37:32] The importance of having a personal tax philosophy when it comes to estate planning
  • [41:34] Additional planning ideas to minimize taxes related to inherited IRAs

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S3 E4 Transcript: Understanding the SECURE Act and Inherited IRAs

Intro

Hi, I’m Cathy Curtis. Welcome back to the Financial Finesse podcast. And if you’re a new listener, welcome. I am this podcast’s host and also an acting and working financial advisor. My firm, Curtis Financial Planning based in Oakland, is an independent firm. And the firm is unique because we specialize in the unique needs of women—particularly women who take the lead in their household finances and are looking for a fiduciary financial partner to help them with their current finances and to secure their future, so they get more enjoyment out of their money today.

In this episode, I interview Megan Gorman, Founder and Managing Partner of Chequers Financial Management, a high-net-worth tax and financial planning firm in San Francisco. An attorney by training, Megan is passionate about the problem-solving required to work in the world of complex financial planning. She is also a senior contributor at Forbes and writes on personal finance and income tax.

As you listen, you won’t be surprised to hear that Megan is an adjunct professor at Golden Gate University in San Francisco as well. She is a very clear communicator and a great educator. And I’m happy to call her a friend, too.

Megan’s expertise is invaluable for today’s topic, inherited IRAs, which is why I’m so excited to have her on the podcast. Specifically, we’re talking about how the SECURE Act of December 2019 changed the rules for certain beneficiaries of inherited IRAs, creating a potential tax headache for some, unfortunately, including tax rates possibly jumping in the years the inherited IRA’s being distributed, and the fact that if you don’t follow the rules, you could get hit with a 50% penalty tax. No thanks.

I think everyone can benefit from this info whether you have an IRA or expect to inherit one. Many who are affected will want to review their current estate plan to ensure it’s still the best plan for all involved. We cover a lot, and it can get dense. So, if you have specific questions about after listening, please don’t hesitate to send me an email. And as always check the show notes for more information and resources related to this episode. You can find more information about me and my firm at curtisfinancialplanning.com. I hope you enjoy the podcast.

[03:30]

Cathy: Hi, Megan.

Megan: Hi, Cathy. How are you?

Cathy: I’m great. Welcome to the Financial Finesse podcast. Thanks so much for agreeing to come on as my guest.

Megan: Oh my god, I’m so excited to be here. I’ve watched a few of your episodes and they’re really, really informative. We can talk about some interesting stuff with IRAs.

Cathy: Oh, we certainly can. Believe it or not, there’s interesting things about IRAs. I first wanted to say where I first noticed you was on a Citywire cover in about 2019. You were profiled, and I was so impressed. And you’re in my area—you’re in the San Francisco Bay Area. And I thought, why haven’t we met yet?

Cathy: And one quote that I really related to, I’m just going to read it real quick. “The thing that I’ve had to get comfortable with over the course of my career is that being a woman with a strong sense of ambition and a strong personality, the best system for me was one that I created on my own.” And I so related to this, because I founded my own firm, and I know you founded your own firm, Chequers Financial Management. And I know it was hard in the beginning, but you’ve been doing it for six years now, is that right?

Megan: We just had our sixth anniversary. Yeah.

Cathy: That’s great. Congratulations.

Megan: Sometimes I wish I’d done it earlier. When you made your career transition from marketing to finance, you just jumped in. And I love that sense of courage and how you took on your practice. Because I think a lot of what we do on a day-to-day basis with clients, is really try to give them the confidence to jump in and embrace their money and embrace what they do.

Megan: It’s hard. It really is. I mean, when people ask me what I do, I often say, look, a lot of times, I’m doing a lot of coaching. I might know the technical rules, but it’s really about pushing you in the right direction for the answer that’s appropriate for you.

Cathy: And you know, that combo of having the technical skills and that other skill set of being able to listen and support is really powerful. And that’s, that’s really what we do as financial advisors. We combine those two things. And personally, I know on the technical side, you are a whiz. Because the other times I’ve seen you is when you’ve been on podcasts, explaining the CARES Act, and you have a really great way of making things understandable—very complex things, which most tax things are—very understandable. So that’s why I’m really thrilled that you’re here.

Cathy: Before we get going on the technical stuff, though, I wanted to ask you. So, Chequers Financial Management—and I know Chequers is the prime minister’s summer residence, right? I wanted to ask you this before. Is there a story behind you picking that name for your firm?

Megan: Yeah, so I’m a British History major, and always focused on the history of England. And when I went to name the firm, I wanted to pick a name that had a couple of meanings. So the term Chequers, the Chequers House was built in the 11th century in England, it was the Chancellor of the Exchequer, his house, the CFO. And for 800 years, it passed through family wealth transfer. And then at the early 20th century, men were starting—and unfortunately not women—but men were rising in society, self-made men, and they needed a place. You know, originally, the country had been ruled by the aristocracy. And they needed to have a place where they could entertain and do business. So the last owners of Chequers House donated the house to the country, so that self-made men would be able to do business. So, it’s an intersection of family wealth and self-made wealth,

Cathy: Right.

Megan: It’s interesting, when you have a firm, you start to attract a certain type of client. And so my, a lot of my clients—not all of them, but I would say that 85% of them—are self-made. I don’t know if it’s because of, you know, my own background. I love stories like that. But I’ve always found the clients I’m working with tend to be the first generation with sizable wealth.

Cathy: Oh, I love that. And so that’s why you named the firm Chequers. It completely fits. And I have to tell you, we have something else in common. I wasn’t a British History major. But I was fascinated by British history when I was younger, and I read everything I could about it. So that’s so cool. I’m really glad that I asked you about that.

Megan: Yeah, no, I love British history.

[08:11]

Cathy: Okay, so let’s get down to talking about the technical stuff. So, the reason I want to talk about the inherited IRA, specifically, is because I have a lot of clients who are inheriting IRAs and/or are growing large IRAs that they are going to give to their heirs. And I’m beginning to realize—you know, the SECURE Act changed the rules about distributions starting January 1, 2020—and that this needs to be paid attention to. Because of the changes, tax bills could really go through the roof. And there are things you can do to mitigate. And I thought, who can I talk to about this? You came first in mind.

Cathy: And so, we’ll start with the basics, so everybody understands where we’re going. Let’s start with what is an inherited IRA? What changed? And we’ll go from there.

Megan: Yeah, so a good place to really put this in context of why this is becoming such a big issue for a number of Americans is, pre-pandemic, Fidelity did a study. And they found that over, I think it was close to a half a million Americans, have IRAs that have balances in excess of a million dollars. Now, they were just doing a study, but put into context is the fact that this is a big issue.

Megan: And so, you know, an IRA is an individual retirement account, whether it’s your traditional one or a Roth IRA. And when you put money into the account, you’re saving it for your retirement. But the thing is, most people don’t spend their IRA down to zero. And so when they pass away, it passes to a beneficiary. And so that’s what we’re talking about here, is when you have your IRA, passing it to the beneficiary, they are inheriting an IRA. And that’s sort of the tricky part of planning. And why I say that is, when we think about estate planning as a whole, we think about our assets—our houses, our brokerage accounts, our jewelry, our cars, things like that. But one of the biggest assets that most people pass on to their family members or friends, and so on, is their IRA.

Cathy: So true.

[10:28]

Megan: The planning you do with your IRA is key. Now, if we go back to before the SECURE Act, and it’s funny, because the SECURE Act came into being in December of 2019, so less than 15 months ago. But truth of the matter is, it feels like a lifetime ago because of the pandemic.

Megan: And it made two really important changes to IRAs. The first is it changed required minimum distributions, the age at which you must take your distribution from your IRAs. It was at 70 ½, and it moved to 72. So that was the first thing it did. The second thing it did is it eliminated this concept called a stretch IRA.

Megan: So, what was the rule before? So basically, let’s say, Cathy, I had an IRA, and I named you my beneficiary, and I passed away, and you inherited my IRA. Before the SECURE Act, you could do something called a stretch IRA, which is, you would be leveraging the IRA tax deferral by just taking the IRA required minimum distributions. You’d take it out over a long period of time, stretching out that IRA. And so, if you lived another 40 years after I passed away, you could be taking distributions over those 40 years if you handled the IRA correctly.

Megan: Now, Congress didn’t like this. And the reason they didn’t like this is Congress wants to get paid. And if you think about it, with an IRA, we put money in pretax, it grows tax deferred, and when you get the distribution, you pay ordinary income tax on it. And so if you inherited my IRA, and you lived another 40 years after I died, right, you might not be paying all the income tax till 10, 20, 30, 40 years after I die. And Congress was like, well, that’s not cool. That benefits rich people.

[12:36]

Cathy: That is so not true, it just blows my mind. Because everybody, like you just named that stat about IRAs. In America, it’s not only rich people.

Cathy: So, you know, I want to give an example. I talked to a client today—just to talk about what you’re saying, to illustrate it—he’s going to inherit, he’s going to split it with his brother, a $500,000 IRA. Under the old rules, he would have to take about $18,000 a year.

Cathy: Under the new rules, he’s going to have to take about $50,000. Although you don’t have to take it each year, you could take it—well, you’ll get into that. But if he did take it each year, it would be $50,000. So think about the difference between $18,000 and $50,000 in tax, and also adding that on to your other income, what’s it going to do to the tax bracket you’re in, etc.

Megan: So I mean, and that’s the—you’re hitting the nail on the head. So that’s what the big change is. So the law was previously, you could stretch it out. And it was, I thought it was a great thing for a lot of Americans because it gave them measured income, like in your example, where the $18,000 a year.

Megan: So Congress changes the rule. And after January 1, 2020, the new rules apply. So for anyone who had an IRA that they inherited pre-January 1, 2020, old rules still apply. People who got, who were now going to inherit after January 1, 2020, what Congress did is basically what you’re talking about. They’re saying, except for a certain group of eligible designated beneficiaries—which we’re going to get into in a moment—everybody else who inherits has to inherit and take the money out over 10 years. They don’t care how you take the money out over 10 years, but 10 years after the date of death, IRA has to be done. U.S. government has to get its money and be paid its taxes.

Cathy: And that is a difference. Before it was a required amount every year. So the difference is now they’re not requiring you to take out an amount every year, you have to just empty it by the 10th year.

[14:54]

Megan: Correct. And so one of the things that’s going to be really key here, right, is the fact that, you know, you need to think about who your beneficiaries are going to be. Because this 10-year rule applies to a lot of beneficiaries. But there are a group of beneficiaries that Congress and the IRS have excluded from the new rule, okay. And so it’s really important to focus on this.

Megan: So the first group, which is sort of obvious, is surviving spouses. So if I have an IRA, and I walk outside, and I get hit by the proverbial bus, and my husband inherits the IRA, he can still draw it out over his lifetime. In fact, spouses have two ways to take a distribution from an inherited IRA. The first is, my husband could step into the shoes of me and withdraw the balance over my life expectancy. Or he could just roll it into his IRA and get sort of a fresh start with it.

Megan: Okay, so for spouses nothing has changed. And that’s important here. Because for a lot of people out there with their IRA planning, the original beneficiary, the primary is going to be their spouse, and the rules are the same. It’s going to be on the contingent side. But let me give you the other groups of people that are given sort of this special designation now. Eligible designated beneficiaries, EDBs.

Cathy: EDBs, let’s call them that from now on.

Megan: Okay, so EDBs. We’ve got the surviving spouse. We’ve got the IRA owner’s children, or child, who are under age 18.

Cathy: Minors.

Megan: Yeah. Just to give you more clarification, if I had a child who was 13, and I named them as my beneficiary, and I walk outside and get hit by the proverbial bus, they could inherit my IRA. And they could stretch it until they hit age 18. And then the 10-year rule applies.

Cathy: Right. And it does depend on the age of majority in the state, right? In some states it’s 21, and that would be the date then. Is that true?

Megan: You know what, I believe it’s 18 because this is federal law. So I don’t think there’s anything different about that.

Cathy: Okay, good to know.

Megan: Now, keep in mind, if you’ve had a grandchild, they do not come under the child provision. So this is child only. The other groups of EDBs are disabled individuals, chronically ill individuals, and any individual who is not more than 10 years younger than the deceased. Okay. And really, that is siblings. Okay. They’re trying to say siblings without saying siblings.

Cathy: Or parents. But that wouldn’t make any sense for a lot of reasons.

Megan: No, because they’re not 10 years or less in age, unless the parents are really precocious.

Cathy: Right.

Megan: So, if you think about it, right, it’s a very specific group. And the two groups that make the most sense, right, are the disabled and the chronically ill. Because if you think about it, they’re trying to add protection there. The major groups—surviving spouse, child under age 18, and an individual who is not more than 10 years younger—you have to really think about this group. The group is a very small group of people.

[18:22]

Megan: So I think the thing that we’ve got to be thinking about here is, how do you want your estate plan to flow? Right? Because what I find when we do estate planning is we do a nice little flow chart when it comes to the will or the trust here in California, right? How it all will pass, how will the assets pass. But I think the beneficiaries, right, you need to be doing the same thing.

Megan: So for instance, if I was to take my situation, I would look at my situation holistically. And I don’t have children. But I have two brothers. One is two years younger than me, and one is eight years younger than me. And in my estate plan, I do want them to have some of my assets. But if I was to look at the whole thing, right, to look at my entire asset base and figure out—how am I going to slice up the pie?

Megan: And I know I want to give a piece of the pie to my two siblings, and I know that they’re less than 10 years younger than me. What I might do is say, well, because they can stretch it out, I might name them as my contingent beneficiary to my husband. Because they can still take advantage of these stretch IRA rules, right? Other people in my estate plan, right, like my mother, my best friend, some of those groups, right, they might not meet the stretch IRA definitions, and they might be better served taking under my estate plan.

Cathy: Right.

[19:45]

Megan: I think the thing is, and I know Cathy, a lot of people who listen to this are, you know, clients of yours and also advisors. I think that given the changes in the law, the first step everybody really needs to make is pull it all together holistically between the estate plan and the beneficiary designation. And really think about mapping assets.

Cathy: And let me let me stop for a second because I think I want to clarify something. So, for the listeners, when you’re talking about the beneficiary designations of the estate plan, the estate plan includes anything that isn’t an IRA with a beneficiary or a life insurance policy with a beneficiary. It’s your taxable assets, your house, things like that. But those are the things that go in your trust. And then on the other side is the IRAs and the life insurance policies that have designated beneficiaries. So, Megan is saying you need to have a holistic plan to combine those two. Just explaining the term estate plan.

Megan: Yeah, no, I think that’s really helpful. And I think one of the things that’s happened over the past decade is estate attorneys have gotten more focused on beneficiary designations. So, you know, I think for everybody, right, the best way to look at your estate plan in general is that it’s a living thing. I always tell clients that this is living, breathing estate plan. And anytime there’s a life event, we should get back in front of the attorney, right? Whether it’s you’ve had a child or grandchild or you got married, all of those things bring us in front of the estate attorney. But the SECURE Act and the changes to the beneficiary rules is also a good point for us to then reach out to our advisors.

Cathy: That’s a good point.

Megan: This is the time that maybe we should refresh this. And I think one of the things that the advising community has gotten very good at is doing a whole balance sheet approach. So Cathy, I’m sure with your clients, you know all of the assets, even if you’re not managing it, right, and I think that’s so important. And I think the ability to go through the balance sheet and say, okay, this is covered by my trust, but this is covered by beneficiary designations is really important. Because I’ve always been surprised at times to realize that people don’t understand how powerful beneficiary designations are.

Cathy: They don’t, they don’t. And so are you saying that you think estate attorneys didn’t focus on that as much, and now they are helping clients more to figure out that holistic approach?

Megan: I think that they’ve always been helpful on it. But what I’m seeing more when I get client estate plans is there’s often a great letter or a summary in the front of the estate plan, and you probably see this as well. You know, saying look, retitle your assets this way, but also say, listen, for your beneficiary designations, this is what it should likely read. And copy that on there.

Megan: But here’s the thing. For a lot of Americans, right, naming the spouse followed by their children might be the easiest solution. But for people who have these very big IRAs, this is where you really have to get into the planning, get into thinking about how you want it to work and how it’s going to flow. Because things sometimes don’t flow the way you think they might until you map it out.

Megan: My first piece of advice here is, because of this change, it’s a great time to connect with your advisor. Go through the balance sheet, understand what goes by the trust and what goes by beneficiary designations, and then work with your advisors to refresh the beneficiary designations, to really, really look at them and make sure it makes sense in context to the balance sheet.

Cathy: Love that advice. Perfect.

Megan: So that’s sort of the first thing because the problem we have, right, is we get into a weird world of taxation. And, you know, I think one of the things that’s been so overwhelming for people is this idea that if they inherit an IRA, right. So if I inherit an IRA from my mother, I have to take out the distributions over 10 years. And it’s a complex rule, because I’m facing income tax consequences when that comes down the path, and it’s how do you manage that? Are there certain tricks out there or ways to think about it that will help you manage the tax piece of it?

[24:19]

Cathy: Let me interrupt for one second. And I totally agree that I want to go into the taxing. So, you’ve been talking about what the owner of the inherited IRA should do, right? And one of them is definitely look at the estate plan and look at the beneficiary designation as a whole. Before we get to the inheritor, the heir, the beneficiary, is there anything else that the IRA owner can do before they die, to reduce tax for their heirs? And is that a wise thing? Do you think that’s a wise planning move to do?

Megan: It’s funny you bring that up. I think that when you, one of the things that you have, as you build your asset base, you have to figure out is what are your priorities. So I have a large group of clients, that the priority there to mitigate taxation, regardless. They just want to make things easier for their children and grandchildren. And then I have other clients that sort of say, look, my spouse and I, we’re protected. It is what it is, whatever happens plays out. So I think there’s a little bit of developing a philosophy on what your priorities are in your asset base.

Megan: Now, if you are one who said, look, I want my kids and my grandkids to inherit. I don’t mind if I have to take some of the pain up front. Some of the things that they should be thinking about is, can you convert your traditional IRA to a Roth IRA? Now, what does that mean? So, as we said, a traditional IRA, you put in pretax money, it grows tax deferred and comes out as paid at ordinary income tax rates. Roth IRAs, you put after-tax dollars in, typically, I’m just giving the broad scenarios. The money grows tax deferred. And when you take your distributions, it comes out tax-free. So if you’re sitting on an IRA, and you’re looking at your beneficiary saying, I don’t want them to pay a lot of income tax down the line. I don’t mind paying the tax. I might convert my IRA to a Roth IRA. Meaning I might pay all the income tax upfront, so that the money in the account becomes a Roth.

Megan: That doesn’t mean we get around the stretch IRA rules, the 10 years. But what it does for your beneficiaries is they can keep them, you know, if you pass away, and your children who were over 18 inherit, the money can stay in the Roth IRA for 10 years growing tax deferred, and then in the 10th year, you can take it all out and therefore mitigated some of the income tax over time.

Cathy: And this is assuming that the person that’s Roth-ing their IRA can afford to pay the tax. That’s why it really depends on what your goals are with your money. Do you want to pay the tax for your kids or your heirs? Or can you afford to do that? Do you need the money to support your lifestyle or whatever?

Megan: Right. Now, I’ll tell you my own personal situation. I mean, obviously, I’ve named my husband. But I’ve named friends. And my attitude is, look, you’re inheriting this. So what you have to pay the tax? It’s more than you had, right, like you’re lucky to be inheriting it. And that’s my sort of personal philosophy on it. You know, you don’t have tax practitioner.

[27:53]

Cathy: You don’t have kids, though. I know I’m thinking of some clients in particular, if you explain this to them—what’s going to happen when their kids inherit. They’re going to go, oh, really? And so then I start thinking, this is the next thing to think about. Who’s in the higher tax bracket? The person with the IRA that might do the Roth, or the kids? Are they high income earners? So, it always gets very complex, these types of decisions, in the end.

Megan: It’s very specific to the to the personal situation. And I just want to add one more element to that. I had someone do this in 2008, during the crisis. But sometimes the best time to be doing this type of planning for whether or not you should convert an IRA to a Roth is when the markets are down. So a year ago right now, right? We were almost at, I mean, right now we’re in April. But last March, March 2020, markets at an all-time low there—that would have been a brilliant time to convert your IRA to a Roth. The thing you got to think about is timing matters.

Megan: So if you’re one of these people who are sitting there saying, look, I’m going to be passing my IRA on to someone who’s not a spouse, who doesn’t qualify as an EDB. And I want to make sure I mitigate all potential income tax for them. And I want to convert my IRA to a Roth, and I have the money to do so, I’d wait till the market dropped.

Megan: In 2008, I remember we did it. I think we did it in like January—it was like December of ’08, January of ’09—and the market, as you know, hit bottom on March the 9th, 2009. And today, we’re at all-time highs. In retrospect, it was a brilliant move because he paid the income tax on a very low amount. But at the time, it was sort of like, I remember him asking me if I lost my mind. And I was like, no, because if you believe the markets will rebound, which you know, I think a lot of investors do, you know, at this point, moving it to a Roth over time, right now, saves you tax dollars down the line.

Cathy: And if they invested it, if they invested it right away in the Roth, they got to participate in the recovery fully, you know?

Cathy: Yeah, timing is super important. I mean, you can’t predict what’s going to happen with that. But you can certainly watch and be ready.

[30:21]

Megan: I would make the argument, you know, part of our job right now is when the markets are on a tear, we need to be talking about planning ideas with clients for when the markets drop. So next time we have a March of 2009, or a March of 2020—weird that it’s always iin March—when those moments happen, you don’t want to be paralyzed in your decision making. You will have wanted to have thought this through.

Megan: So I would challenge you to say if we went back to where we were on March 27th 2020, which was the bottom of the pike, technically, the bottom of the market when the CARES Act was signed. You know, looking back now, do you wish you had converted your IRA to a Roth and paid those tax dollars on it, given the growth in your IRA? And these are the questions people have to ask.

Megan: I don’t want to lose track of the beneficiary designation. So if you’re an IRA owner, my advice is flowchart out how your IRA is going to pass. Remember, if it passes to your spouse, you’re still under the old rules. If your contingent is not in the group of EDBs, then you really need to think about that group. And think about what is your philosophy on taxation? Do you want to pay the tax for them? Or do you not? Do you even care? I mean, are you saying, look, you’re inheriting something. God bless.

Cathy: And there’s nothing there’s nothing wrong with that attitude, by the way.

[31:47]

Megan: Right. Now, the tricker thing is, the person who inherits it. So you know, we’ve been using a scenario, right, where if you inherited my IRA, Cathy, you’re going to have a whole host of decisions that you have to make when I pass away. Because you get told, okay, you’ve inherited an IRA, what do you want to have happen? And this is where, as the beneficiary, you really need to work with a tax professional or another advisor who can lay out taxation for you. And to sort of map out the next 10 years, what does it look like, right?

Megan: Because you might be working for the first five years of the 10 years. And the last five years, you might be retired, and so your income bracket might be changing. And so what you want to be doing is roughly mapping out where you think your ordinary income tax bracket is going to be.

Megan: Now, some people would say, look, if your bracket’s going to remain the same the whole time, you just might want to take a piece out every year, and so be it. Other people might say, look, wait till the very end, wait till the 10th year, and then take it all out.

Cathy: There’s the other factor that predicting tax rates, like, right now we have an administration who might raise taxes. So you have to think, will I be taxed at a higher rate later, in that 10-year time frame? Or should I take it now? That’s another thing to consider.

Megan: Because there’s also a third group, right, of people who are trying to, they might have a high tax bracket, then a low, then a high, then a low. And you can intersperse the distribution that way. But I think, what I tell people about retirement planning is—we talked about me being a history major—I think of things on a timeline. Seventy-two, as we talked about. If they start taking the RMD before 62, they might still be working, but 62 to 72 is usually that first sort of decade of retirement.

Megan: And what a lot of them experience in that decade of retiring is they might be taking Social Security, but a lot of their income might be coming from their investment portfolio. And they might be municipal bonds, which are tax-free, or qualified dividends at preferential tax rates. And that might be the sweet spot to pull down a lot of the income to fill in the gap.

[34:03]

Cathy: Let’s repeat that, because that’s a really important point.

Megan: Yeah, I mean, I think the thing is, when you’re working with your advisor, they typically do a long-term cash flow. I think it’s the best tool out there. And Cathy, do you use them with your clients?

Cathy: Oh, yeah, I do this kind of planning, where in that that period you’re talking about—where you’re looking at—right when you retire before you take RMDs. It’s a really critical planning time.

Megan: It is, and it’s where your income tax, you know, if you do that sort of long-term cash flow, you typically can see between ages 62 and 72, there’s a reduction in taxation. Because most people go from paying a lot of ordinary income tax to preferential tax rates, right? They have municipal bonds that are tax-free, they have qualified dividends, and they often have Social Security, but their brackets drop.

Megan: And that’s where layering in IRA distributions can be incredibly powerful because you’re going to get more money out, but at a lower tax rate. And where I think anyone who’s inheriting an IRA really needs to think through sort of when they take it, and when they can take advantage of certain tax rates.

[35:11]

Cathy: Yeah. Could you talk a little bit about the whole Medicare and IRMAA charge thing, too? Because that’s something else that people need to think about.

Megan: Yeah, so there is a surcharge for Medicare. And I always find it, you know, it’s frustrating, because people don’t expect it. Medicare will surcharge you if you make a certain amount of income on your Medicare payments. So that’s frustrating for people, because first of all, Medicare looks back two years on your tax returns. And they add back any municipal bond income that you had. They’re really trying to figure it out.

Cathy: You know, the point you just made is so true. Why does—no one knows that. Everyone thinks that it’s that bottom line, monthly Medicare fee. And it’s not. And people are always surprised that they’re paying more.

Megan: I was on a call with a client yesterday. And I mean, she’s now 71. And I’ve heard for six years about the Medicare surcharge, because they add back for muni bond income. Because she’s like, look, I did the right thing. I structured my asset base appropriately.

Megan: But I think the thing is, those are the nuances you have to add in. And look, I’m going to be honest, sometimes tax is tax. You can’t mitigate it. And if you can’t mitigate it, you want to think about all the other planning levers that are around you.

Megan: So, one of the big things out there—and I know you’re a big fan of it—are donor-advised funds. So if you’re going to have to take the distribution, either over 10 years, or in a couple of years, from an inherited IRA, you may choose to take the distribution in a year that you can make a donation to charity. Or fund a donor-advised fund, where you put some of the money right to charity and mitigate the tax bill that way. And that might be another way to handle it.

Cathy: Another point with the donor-advised fund is for the IRA owner, if they decide to Roth part of their IRA, is to do a donor-advised fund contribution in that year. That would mitigate some of the tax on that Roth conversion.

Megan: There’s not a one size fits all solution. There’s a lot of different options out there, and you have to work through them, depending on your personal financial situation, and who you are as a person. What are your values, your value proposition?

[37:32]

Cathy: It’s so important that you’re bringing that up. Because, you know, when I wanted to do this podcast, I was really focusing on how can we help our audience save, learn how to save tax, given this new rule? And the truth is that paying tax isn’t really the worst thing in the world, you know. You’re paying tax on income, so you obviously have income coming in. And it really does depend on your own personal philosophy.

Megan: Yeah. And, you know, I’m sure you use investment policy statements. And I think whether you work with an advisor or not, you should have an investment policy statement for your asset base that lays out the mandate.

Megan: And we try to put in ours what people’s tax philosophy is. So, you know, I’ve got things like they hate refunds—they don’t want the government having that loan from them—to do everything possible to mitigate income tax and estate tax issues. And it’s trying to find that balance. Because, you know, anytime we have a law change, it might close one door, but it opens another door. And what’s why you want to go down that path of doing that type of planning.

Megan: And I have a lot of clients who have very complex situations, and they do complex planning. And then I have another group of clients where they’ll say, there’s elegance in simplicity. I’m not going to overthink it. I don’t know where tax rates are going to go. I’m going to let my beneficiaries figure it out.

Megan: But the beauty of the changes in this rule here for beneficiary designations is both the IRA owner and the inherited IRA beneficiary all have planning choices to make. Everybody is able to control some of the controllables. And so, the thing is, when you inherit an IRA, what’s really, really important is to seek advice. To reach out, get help, because people like you and me, we’re trained in thinking through these parts of the problem and understanding in context of the bigger picture. That’s important.

[39:30]

Cathy: Yeah. And some real mistakes can be made, like the contingent beneficiary. I mean, there could be some huge tax owed if people don’t understand how the beneficiary thing works and who’s the eligible designated beneficiary and who’s not. Someone doesn’t take anything out of their IRA dies and then their beneficiary ends up paying tax on a huge IRA.

Megan: Things like that can happen. It happens all the time. And yeah, you know, these are in a weird way—if you inherit an IRA, it’s a bit of a champagne problem. It’s a good problem to have, right? You’re working through it. But I also would say to people who, to all of us who have IRAs and 401(k)s and 403(b)s, this is the cheapest estate planning you can do, right?

Megan: Because in California, when we do an estate plan, we have to go out and get a revocable trust. But beneficiary designation planning, if you set your beneficiaries up, and in five years, your life has changed. Maybe you were married and then you got divorced. Or, you know, you’ve determined that one of your children doesn’t need the money, but your other child does. It’s all about just changing a form. And that’s the thing I like about beneficiary designation planning. It’s quick and easy to fix.

Cathy: I have some of my clients with simpler estates use transfer on death beneficiaries for their taxable accounts instead of doing the trust for that very reason. Because it’s simpler.

Megan: Yeah, I mean, I’ll tell you here in California, you know, when you get your revocable trust, they’re like change your bank accounts. And I’m like, oh, God. The first time you go to the bank and try to do that, the practical aspect of it is difficult. People inherently like to procrastinate on this.

Megan: So like you do, sometimes I’ll say just make it TOD or POD account at the bank. It just makes it easier than getting into the trust, because it’s, it’s just, it’s difficult.

[41:34]

Megan: Now, I do want to mention a couple other planning ideas. Because, you know, one of the things that people talk about was with stretch IRAs, you were creating this unique estate planning tool for your beneficiaries. Right? So one other idea out there—and it comes with a cost—is the IRA owner can also choose when they’re taking their RMDs. If they don’t need the RMD to live off of, they can pay for life insurance, and that life insurance can then go to the beneficiaries of their death. And they don’t have to deal with this income tax issue.

Megan: And that’s one of the things out there that people are starting to use to replace it. It’s not my favorite technique, because I find life insurance at times can be too expensive. But if you’re really, really caught up in making sure your beneficiaries get a certain amount, and get it income-tax-free, life insurance is one of the levers you can pull in your financial picture to make that happen.

Cathy: Yes. Yeah, that is a little more complicated and more expensive. But again, it depends on the person. For the right person, that could be the best strategy.

Megan: And I think that’s the thing where, you know, the beauty of working with an advisor is our roles are to bring to the forefront things that we don’t want to deal with. We force conversations that people put off. And I think one of the best conversations we should be having—and we do have—with clients is how does this all flow? How does it all play out? And I found when I start to show clients how the estate plan flows out and the dollar amounts, it can sort of take them by surprise.

Cathy: Yeah. And they’re certainly not thinking about that. You know, who spends time thinking about these things? I’ll give a good example of another planning technique that just came up today around inherited IRAs. One technique to reduce the IRA before the person dies—and if they’re older, this kind of makes sense. If they’re taking their RMDs on a monthly basis, you may want to take the whole RMD as early as possible, just in case. You know, if they’re in their 80s or 90s? So that the money is out of the IRA.

[43:56]

Megan: Yeah. That could work. You know, and also, you could just choose to take larger distributions. You’re in your 70s or 80s. And your main sources of income are your IRA and your Social Security check, right? Maybe you start taking larger IRA distributions. I mean, there’s no harm in it. Again, work with your advisors to make sure from a tax perspective you’re not getting burned. But it might make a lot of sense for a lot of people, you know. And how to do and how to structure it.

Megan: I can’t emphasize enough, you know, tax planning—and I know Cathy, you use a tool with your clients that you have found really effective. But, you know, I agree. Planning is so key as you project ahead, because there’s power in that knowledge in trying to be tax efficient. I can’t tell you how many times people are like, “woulda coulda shoulda.” If I’d known that’s how it was going to play out tax-wise, I would have done this differently. And so working with advisors like Cathy, who have those tools, I think it’s so valuable.

Cathy: I do too. You know, I always do tax planning. But I tell you, it was a lot of work when you were using spreadsheets to do it. And there’s new software available to financial advisors that’s incredibly powerful where you could do scenario planning for years out. And, I find in my role as a holistic financial advisor where I do financial planning and investment management, and I know everything about the client, that is so helpful and powerful for them. And because tax accountants, I don’t do tax returns, and many accountants don’t know the whole thing. So it’s really good to have somebody that does to help you, especially with these kind of issues.

Megan: Because you can then say, look, even though we’re going to take a larger distribution, let’s donate to charity more. I know you’ve been doing more to your alma mater, right? Things like that. And it’s that little nuance there that can make the difference.

Megan: And I think it’s important to quantify the tax savings, right? And remind people when we’ve done a strategy—over time, what has that strategy added to your portfolio? It’s like, I told you the story of my client who converted his IRA in ’08, ‘09. I mean, here we are 12 years later. I mean that’s, for him, a seven-figure difference. That has value.

Megan: It’s painful paying the tax, but a certain point, you cross over where you’re winning. And that’s so important when we’re managing our finances is—you want, I want clients to feel smart and clever about the choices they made. And even if the choice is, like I’m saying, I don’t care if you inherit my IRA, and you pay the tax. Good luck. Have at it. That’s a proactive decision. You know, look. Ultimately, the SECURE Act, I think it hurts more Americans than it helps.

Cathy: Wait, wait, what does the acronym stand for? It makes me laugh.

Megan: Setting every community up for retirement enhancement.

Cathy. Right! How is this enhancing? I don’t see—it enhances the coffers of the government. I’ll tell you that, you know.

Megan: So, but here’s the thing. What if the opportunity had been different? That if you inherited an IRA, you had an option that it was, you know, it was almost like a pension to you. And you got to, you know, talk to an advisor, who explained this thing could be like a pension for the rest of your life. Don’t pull it all out.

Cathy: Yeah. Which it was. That’s really what it was. It was an excellent tool for people.

[47:36]

Megan: Yeah, I’m disappointed that they did this. You know, I think that unfortunately, we live in a day and age that when they’re setting tax policy, there is such a need to be punitive to people who have been financial success. Right? That sometimes the typical American, right, the average American who have worked so hard to save this money. And they’re sitting there, and they have five, eight, $900,000 in the IRA. They’re getting penalized because there are a few wealthy people that also got benefits.

Cathy: Right. You know, good point. Because we didn’t, we haven’t talked 401(k)s in relation to IRAs. But you said people have big IRAs. One of the reasons is they’ve been saving in their 401(k)s their whole life or their 403(b)s or whatever. And then they retire, they convert it to an IRA, and then someone inherits it. I mean, that’s the way a lot of, in some cases, that’s the only way people are saving money. So, it really is penalizing a broad swath of people in the United States, not just uber-wealthy.

Megan: It is. And you know, I think the other thing is it’s one of these things where there’s also planning that can be done while you’re building the wealth, right? So, I have a lot of clients where one spouse is working, and the other one doesn’t. And we still fund an IRA for them. And if we can, we convert it to a Roth.

Megan: And a lot of times we’re doing it because, you know, one, it gives us the chance to create a vehicle that’ll create tax-exempt income. But also, two, even though they name their spouse as the primary beneficiary, and maybe their children as the contingent, they also are making the decision that the spouse could eventually disclaim the IRA, the Roth IRA, if it’s inherited, and go right to the kids. Granted, the kids have only 10 years to take it out. But it’s tax-free money, right? It grows tax deferred.

[49:30]

Cathy: Okay, let me let me ask you something. I thought about this before we talked. If someone disclaimed an inherited IRA, and it went to EDB, would they get to take it over? I mean, they get to stretch it?

Megan: So, yeah. If it was an EDB, like if my husband disclaimed it and it passed to my brothers? Yeah, they can stretch it.

Cathy: Okay. That’s interesting.

Megan: That’s, that’s some of the nuances there. Yeah. I think you know, it’s one of these things where, know who you want to give to in your family. Right? How far out do you want to give? Nieces, nephews? You know, and you might do nieces and nephews in your actual trust, but you do your siblings in the IRA because of the stretch privileges.

Megan: And that’s some of the stuff you just, and you can see just even in this podcast, some of it is just sitting around and kicking the can around. If you have a beneficiary who has spending issues, you might be better served putting them in your trust, in your estate plan, your trust part of it, and not give them access to an IRA. But that’s also problematic.

Cathy: Right. They might drain it all in the first year, right?

Megan: Yes.

Cathy: Yeah. And you can set up trusts where they get the money at a certain time. And you can’t do that with an IRA. It’s their money.

[50:48]

Megan: The other thing is, when you’re the IRA owner, think about dead—I love the term from the law—dead hand control. How much dead hand control do you want on your beneficiaries receiving something? Because if you had two siblings, and one of your siblings had a drug issue or spending issue and your other sibling didn’t, you could say, look. I’m going to give you my IRA. You’re going to have to pay some tax on it, right, but you’ll probably be able to stretch it.

Megan: I’m going to give our other sibling money in the trust. And they might get less from the trust than you’ll get in the IRA, because net-net, you’ll get the same after tax. That’s the type of nuancing that you want to be thinking through.

Megan: And estate attorneys, financial advisors, CPAs—these are all great people to have the debate with. And, you know, sometimes get them all in one room. You know, get everybody in one room and say, look, I want to do my beneficiaries. And I really want to think through this. Let me tell you about all the people I’m thinking about, and what I’m concerned about with each of them, or what I’m not concerned about with each of them.

[51:51]

Cathy: Right. Oh, I have a question for you. Nondeductible IRAs. If someone’s eligible, even a very wealthy person, would do you do those?

Megan: Totally. And I file form 8606. Which records the basis and tracks it.

Cathy: Do you put it into the same IRA? You don’t do a separate IRA for the nondeductible contributions?

Megan: In general. I mean, I keep it in the same IRA. And it depends, because some of the people we’re doing it with have such large pretax balances that they can’t do a Roth conversion. But then I have a group that every other year, we’re funding it and doing the Roth conversion.

Megan: And look, I’ll say this for what I have found—and maybe it’s because I’m a woman—but I will often run into situations where, you know, the husband is the working spouse and the wife has stayed at home. And I think it’s incredibly important for women to have their own money. And it might not seem like a lot at first putting the $6,000, or $7,000 away if you’re over 50. But, you know, as I say, over 10 years of doing that, plus the growth, that turns into six figures pretty quickly.

Cathy: No, I agree. Spousal IRAs are—definitely. So, you take advantage of any tool that is out there, no matter how small. Like with the deductible IRAs, it’s only six or $7,000 a year, right. But then those earnings grow tax free. If you keep it in, if you keep it in the nondeductible IRA.

Megan: What I tell clients is, look, if there was $20 on the floor, I’d pick it up before I left the room. You know? Every little bit. Because if you max out your 401(k), and you fund your IRA, and then you add to your brokerage account, and maybe you fund your kids’ 529, and you add it all up, all those little things become a big number.

Megan: And we need to celebrate that more, because it is so hard to save today. You know, I always tell people, what’s fascinating to me is the government determined that upper middle class starts at income of, I believe, $127,000. That’s where the government feels like you should be set. And I’m sitting here in the Bay Area, and that is still tough living on $127,000. How do you save?

Megan: And the system since the 80s has been made to work against you. So, if you are a beneficiary of an inherited IRA, it’s a blessing. And you need to think through it because it can be one of those things that makes the difference between a financial challenge and a financial success over the long term.

Cathy: Right. Because it is a gift. It’s a gift, right? An inherited IRA is getting a gift, and you want to take care of it.

[54:39]

Megan: And you know from all those studies. You know, Merrill Lynch does a study every year on this, the focus is on family. And I believe what the study has found is that there are so many boomers and Gen Xers who are building their entire retirement strategy on inheriting because they can’t fill the gap and they’re all living so long. So, that’s the tough part.

Cathy: No, it really is. Well, this has been just as interesting and thoughtful as I thought it would be. You’ve given me some new ideas around this topic. I really appreciate you coming on. Is there anything else you want to add on the top? I mean, we could probably talk forever about this.

Megan: One last thing I would just say to anyone who’s doing this is engage in your planning. These are big dollars. Whether your IRA is $50,000 or $500,000. It’s big numbers, and you want to have some control on how it plays out, so really get engaged. And talk to your advisor. It’s well worth it.

Cathy: I agree. And so, let’s tell our audience where they can find you. I know you write for Forbes, and you probably do some other things. So please, yes.

Megan: So you can find me at Forbes at www.forbes.com/MeghanGorman. And then you can also find some of my other planning pieces at thewealthintersection.com. So you know, I love to do webinars and write about this. I think my role in this space is about helping people thrive. It drives my husband a little crazy, because we’ll be out and about, and I’ll be trying to give people advice. But I love this stuff, though. If you want to read my articles, feel free and feel free to reach out.

Cathy: And give people your Twitter handle for those that are on Twitter.

Megan: Sure. It’s @megan_e_gorman. So feel free to reach out on Twitter as well. But thank you for having me on. This was great.

Cathy: I want to do this again on another topic, okay?

Megan: You got it.

Cathy: To be decided.

Megan: You got it. Sounds good.

Cathy: All right. Take care.

Megan: Take care.

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Forward-Thinking Tax Strategies to Implement This Year

Many people dread tax season. The idea of digging through all of your financial records, working through the filing process, and hoping you submitted everything correctly to avoid an audit is stressful.

And the worst part? It kind of feels like you can’t win. If you have your employer withhold too much money from your paychecks for taxes, you’re essentially giving the government an interest-free loan (even if the refund is a fun windfall). On the other side of the equation, if you underpay on our taxes over the course of the year, you could owe a significant amount of money.

As much as we may wish that we could wave a magic wand and have the tax season stress eliminated from our lives – that’s not a real possibility. As the old quote from Benjamin Franklin goes, “Nothing can be said to be certain, except death and taxes.”

If we can’t avoid dealing with taxes, we need to find positive ways to incorporate them into our financial plan. Luckily, there are a few things you can do to lower your taxable income and make next filing season easier.

Check Your W-4

According to NerdWallet’s 2018 Tax Study, only 35% of Americans are aware that they can adjust their federal tax withholdings anytime over the course of the year. Your withholdings can help you to adjust the amount of taxes you pay out of your paychecks to ensure that it’s correctly calculated based on your current income and your total number of exemptions you claim.

As your lifestyle changes over time, the information on your W-4 should change. For example, if you don’t claim your spouse, children, or other dependents on your W-4 as exemptions, you might consider making adjustments to reflect your current living situation.

Look to Reduce Your Taxable Income

If paying taxes overwhelms or frustrates you, you may be able to take advantage of a variety of savings accounts that help you to save money on your taxes. These accounts also help you to achieve long term financial goals – like growing your wealth for retirement planning, saving for your children’s college education, or covering medical expenses.

Retirement Planning

Your workplace 401(k) is a tax-efficient account. In other words, it’s funded with a portion of your income that’s pre-tax. Other retirement savings vehicles that are funded with pre-tax income are:

  • 403(b)
  • 457 plan
  • Traditional IRA
  • SEP IRA

Using these retirement savings accounts to lower your taxable income is a wonderful way to lower your current taxable income while maximizing your money and preparing for future success.

529 Plans

As a result of the new tax code, 529 Plans are no longer just for college education expenses. Parents can use a 529 plan to fund their child’s education from elementary to high school, as well. However you choose to use the funds in your child’s 529 plan, it’s important to note the tax benefits of these accounts. All earnings from a 529 plan grow federal tax-free, and you won’t be taxed when you or your child choose to tap the account.

Although this account doesn’t technically lower your total taxable income, being able to save for your children’s education and not face a capital gains tax when you finally access the funds is a tax benefit that’s essentially unmatched.

HSA and FSA

A Health Savings Account and Flexible Spending Account are two other key ways to save money on taxes for next year. Although you may need to meet certain healthcare plan requirements to open them, if you’re eligible – they offer another opportunity to reduce your taxable income.

HSAs, in particular, are instrumental in tax efficient financial plans. As they’re funded with pre-tax money, just like your 401(k) or other workplace retirement plan, they lower the amount of income that’s viewed as taxable by the IRS. However, they also roll over from year to year and can be used for qualifying medical expenses.

Whether you have large medical expenses in your future that you’re planning for, or you just want to save for the inevitable increased health-related costs associated with aging, HSAs are an excellent savings vehicle to use.

Get Organized and Speak With a Professional

No matter what strategy you choose to implement, it’s wise to get organized now. Don’t wait until next filing season to get started, you’ll only cause yourself equal amounts of overwhelm and frustration. Instead, stop the cycle by reaching out to a financial planning professional to learn more about these and other options to optimize your finances and reduce tax-related stress.

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Clearing up the confusion over the Gift Tax Law, updated for 2018

There are many confusing tax laws, but the one that seems to generate the most misunderstanding is the gift tax law.

Many are aware that gifts can be made up to $15,000 in 2018, (this amount is periodically adjusted for inflation) with no tax consequences – but beyond that it’s fuzzy. A client asked me if she would have to pay tax on a $100,000 gift her parents were planning to give her to buy a house. The answer is no.

Here’s the low-down on the gift tax law:

1. Anyone can make gifts of up to $15,000 (in 2018) to as many people as they choose without any tax implications. This gift is called an “annual exclusion gift”- meaning the gift is tax-free for the giver and the receiver.

In each following year,  the donor can start all over again giving gifts up to the annual exclusion amount to as many people as they choose. The gift can be either cash or goods. The gift does not have to be to a family member, it can be to anyone the giver chooses. In addition, married couples can each give $15,000 a year, so your grandchild could receive $30,000 from you and your spouse in a given year.

2. If a donor exceeds the annual exclusion ($15,000 in 2018) to any one person, that is also a tax-free event – unless the gifts go over the generous lifetime estate and gift tax exemption of $11.18 million per person.  A minor annoyance:  Form 709 – United States Gift Tax Return – must be filed with that year’s tax return. But NO tax is due.

3. The recipient of said gifts (of any amount) does not pay tax on the money ever, at all.

If a gift tax return (Form 709) is required, it will be due on April 15 of the year following the year in which the gift was made.

Let’s step back and define what a gift is for IRS purposes:  It’s something that is given and nothing is received in return. It is complete as a gift. Loans are not gifts.

What are some of the reasons people give gifts?

  1. They are generous and kind.
  2. They want to help a loved one with expenses such as a down payment on a house,
    education costs, or a vacation.
  3. They are very wealthy and want to reduce the size of their estate and therefore, estate taxes.
  4. They know they won’t spend all their money during their lifetime and want to
    share it with their loved ones before they die.

Examples:

1. You and your spouse decide to give $15,000 each to your four grown children for Christmas. The total gift amount is $120,000. No tax is due and no gift return is filed.

2. The Brown’s gives $200,000 to their daughter Sally, to assist in the purchase of her first home. A gift tax return (Form 709)  for $170,000 ($200,000 –  $15,000 x 2) would be filed with that year’s tax return.  In subsequent years, any gifts the Browns’ give over the exclusion amount will be added to the $170,000.

How the estate and gift tax are tied together:

Let’s say the Brown’s, over their lifetime, gift $1,000,000 in gifts over the annual exclusion amount. When they die, the $1,000,000 will be subtracted from their lifetime estate and gift tax exemption – $11.8 x 2 =  $22.36 million – $1 million  = $21.36 million or $10.68 million each.

It’s obvious that very few but the most wealthy will exceed the estate and gift tax exemption, and in consequence few people pay estate or gift tax. This wasn’t always so. The basic exclusion amount (or applicable exclusion amount in years prior to 2011)  was $1,500,000 (2004-2005), $2,000,000 (2006-2008), $3,500,000 (2009), $5,000,000 (2010-2011), $5,120,000 (2012), $5,250,000 (2013), $5,340,000 (2014), $5,430,000 (2015), $5,450,000 (2016), and $5,490,000 (2017).

Spousal gifts and portability

Spouses fall under different rules when it comes to gifting and estate or gift tax. The unlimited marital deduction allows you to gift any amount of money or property to your spouse without incurring either the federal gift tax or a state gift tax if you live in a state that imposes one.

In addition, in 2013, Congress passed the American Tax Relief Act of 2012 (“ATRA”). One of the key provisions of ATRA is to make permanent the portability of the applicable exclusion amount between spouses, which was enacted by Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010.

Portability allows the first spouse to die to transfer his/her unused estate tax applicable exclusion amount to the surviving spouse, who can then use it for his/her gift or estate tax purposes. The key is to be sure to file an estate tax return at the first spouse’s death to elect portability.

Gifts made directly for education or medical expenses qualify for exclusion.

Payments that you make on someone’s behalf for qualified tuition or medical expenses do not count towards the annual limit for gift tax purposes. This means that you can pay for a child’s tuition in the amount of let’s say $20,000 and if it is paid directly to the institution, you can still give that child $15,000 that year.

However, your payment(s) must be made directly to a qualifying educational organization or medical care provider in order to qualify for the exclusion.

In the case of 529 contributions, these gifts are considered part of the annual gift exclusion.  So you can give $15,000 a year to a 529 plan (or you can also give 5 years in one year or $70,000 and use up 5 years of the exclusion amount).  Note, these contributions are not made directly to an institution.

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6 Year-End 2016 Tax Planning Tips and Reminders

Tax Planning Tips and RemindersDon’t let the year slip away without doing a little tax planning – the financial benefits will be worth your time. All of the below tips and reminders must be done by December 31, or you either forfeit the opportunity or pay penalties.

1. Max Out Qualified Plan Contributions

If your cash flow can stand it and you haven’t maxed out your 401(k) or 403(b) yet, talk to your payroll department to increase your contribution before December 31st.

For those under 50, the maximum contribution is $18,000, and for those over 50, the maximum contribution is $24,000. At the very least, be sure you’ve contributed up to any employer match.

2. Take Minimum Required Distributions (MRD’s) from Inherited IRA’s

If you have inherited an IRA from someone other than your spouse, you must take minimum required distributions beginning the year after the death of the original owner and by December 31st of that year.

To calculate the MRD, the IRS has a Single Life Expectancy table you can find by searching the IRS website. Or, Schwab and Fidelity and other custodians have on-line calculators to help you with the calculation. Be sure to have on hand the date of death and birthdate for the original owner and the balance of the account on December 31 of the previous year.

3. Take Required Minimum Distributions RMD’s from your Retirement Accounts.

As an owner of a traditional IRA, SEP, Simple IRA or company retired plan (401(k), 403(b) or 457 plan, you must start receiving distributions by April 1 of the year following the year in which you reach age 70½. You figure your required minimum distribution for each year by dividing the account balance of December 31 of the preceding year by the applicable life expectancy. Life expectancy tables are located on the IRS website. You must calculate the RMD separately for each IRA that you own, but you can withdraw the total amount from one or more of the IRAs.

Similarly, a 403(b) owner must calculate the RMD separately for each 403(b) contract that he or she owns but can take the total amount from one or more of the 403(b) contracts. However, RMDs required from other types of retirement plans, such as 401(k) and 457(b) plans have to be taken separately from each of those plan accounts.

If you don’t need the money and want to avoid tax, some or all of your required RMD can be donated directly to a charity. The donation counts as your required minimum distribution but doesn’t increase your adjusted gross income, which can be beneficial if you don’t itemize and can’t deduct charitable contributions.

Also, keeping some or all of your RMD out of your adjusted gross income could help you avoid the Medicare high-income surcharge or make less of your Social Security income taxable.  The money needs to be transferred directly from the IRA to the charity to be tax-free.

If you withdraw it from the IRA first and then give it to the charity, you can deduct the gift as a charitable contribution (if you itemize), but the withdrawal will be included in your adjusted gross income.

4. Roth IRA Conversions

If you have a traditional IRA, you might want to consider converting some or all of the balance to a Roth IRA. Roth IRA’s are a valuable tax-planning tool due to the favorable tax status once the money is inside the Roth IRA.

If all the rules are followed, you may never pay tax on your Roth balance and your heirs may not either. However, tax is due when you convert an IRA to a Roth, so the conversion makes sense if your income is lower than usual or you believe that your tax rate will be higher in future years. For example, if your income dropped in 2016 due to a job change, you might consider converting some of your IRA to a Roth because you will be in a lower tax bracket and pay fewer taxes than you might in future years. Be sure and take note that under Trump’s new tax plan, your tax rate maybe lower next year.

The deadline for conversions is December 31, 2016, but you will want to do this by at least December 22nd to make sure the paperwork gets processed with your custodian.

5. Establishing a New Qualified Retirement Plan

If you are self-employed and want to establish a qualified plan such as a 401(k), money purchase, profit-sharing or defined benefit plan, it must be set up by December 31st. Many people confuse this deadline with the SEP IRA deadline that can go into the next year, including extensions.

You can set up a SIMPLE IRA plan effective on any date between January 1 and October 1, provided you (or any predecessor employer) didn’t previously maintain a SIMPLE IRA plan. If you’re a new employer that came into existence after October 1 of the year, you can establish the SIMPLE IRA plan as soon as administratively feasible after your business came into existence.

6. Review Your Charitable Contributions

If you itemize deductions and are charitably minded, you will want to donate what you plan to before December 31st. You may deduct an amount up to 50% of your adjusted gross income, but 20% and 30% limitations apply in some cases. Good to know: donations made by check are considered delivered on the day you mailed it.

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Finglish Lesson #3: “Fiscal Cliff” and “Taxageddon”

Easy English Dictionary

Easy English DictionaryThe “fiscal cliff” and “taxageddon” refer to a convergence of fiscal events (or government spending and tax policies that influence the economy) slated to occur almost simultaneously at the end of 2012. If these terms aren’t on your radar yet, they are sure to be soon, as the media loves nothing better than drama and bad news and there’s plenty of that in this story.

The actors are the President, Congress, and U.S. taxpayers. The stage is the fragile U.S. economy. Like all good dramas, this one has lots of tension. The drama began decades ago when the U.S. started deficit spending, was exacerbated by the healthcare battle and the recent Great Recession, and came to a head last summer when the U.S. almost defaulted on its debt.

All kinds of political machinations took place to avoid a default—deals and compromises that were short-term stop-gaps, and all are coming due at the end of this year. You might say, “Surely the President and Congress can do something to stop Taxageddon?” Yes they can, but they won’t until after the November elections, leaving everyone at the edge of their seats—a true cliff hanger.

Hang on to your seats, and keep reading. Here is the fiscal cliff script:

  1. Tax rates for every income group will rise to levels not seen since 2001 (better known as the expiration of the Bush tax cuts). The current 10%, 25%, 28%, 33% and 35% rates will shift to 15%, 28%,31%,36 % and 39.6%.
  2. The tax rate on long-term capital gains will go from 15% to 20%. The maximum rate on dividends will increase to 39.6%.
  3. Some 3 million Americans will lose unemployment benefits.
  4. The Pentagon will start 2013 with a $55 billion budget cut; the budget for non-defense spending will be cut by the same amount.
  5. Soon after the beginning of the year, federal payments to doctors who treat patients covered by Medicare will be slashed by about a third.
  6. Higher-earning individuals ($200,000 for individuals and $250,000 for families) will be subject to an additional tax of 3.8% on all investment income: interest, dividends, capital gains, rents and royalties.

If all of these spending cuts and tax increases become reality, a significant slowdown (recession) is likely to result. This translates into continuing high unemployment, a volatile and downward-trending stock market, and generally unstable economic conditions.

In the final act, Congress and the Obama administration will fight it out over the last six weeks of 2012, negotiating, compromising, eliminating one thing, extending another, and once again avoiding disaster. But what remains to be seen is whether the U.S. economy will right itself or remain perched on the edge of the cliff.

How do you think this story will end?

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“April is the Cruellest Month…” or You and Your Taxes

If you’ve been reading my blog, you know that I’ve been writing about the Ten Simple Truths About Money.  These truths are meant to act as a framework to provide new ways for you to think about money that are easy to understand and implement.  Simple Truth #4 is “Inflation and Taxes Are Money’s Enemies.”  This is a big topic so I broke it down into two parts. Today’s post will cover part two:  Taxes …. and Tips to Ease the Pain. To read part one, click here.

April showers bring May flowers
April showers bring May flowers

“April is the cruelest month . . .” begins the first line of The Waste Land, the signature modernist poem by T.S. Eliot.

The poem had nothing to do with taxes. However, with the goal to raise awareness about National Poetry Month, the Academy of American Poets and the American Poetry & Literacy Project cleverly came up with the idea to distribute thousands of free copies of The Waste Land to selected post offices on tax day.  At least anxious taxpayers had something pleasant to read after they dropped their returns in the mail!

The first half of April can be very stressful and yes, cruel, if you aren’t organized or run out of funds to pay your tax. With the exception of an IRA contribution, there is nothing you can do to alter the outcome in April.  (Yes, you can file an extension, but you still have to pay the taxes due).

But taxes are money’s enemy on more than just tax day.  Taxes can erode the value of your investment portfolio and eat away at your income all during the year.  We all have to pay our fair share, but there are tips and strategies that can be implemented to help keep more of your money in your pocket and return thoughts of April to lovely Spring weather, longer days, strawberries and sweet English peas!

Tax Planning Strategies To Keep You Sane

Get Organized.
If you don’t do anything else, setting up a filing system for tax documents is a must. Not only will everything be in one place when you need it, but you are less likely to miss out on deductions when you are consciously filing receipts and documents all year. A series of folders with labels such as charitable contributions, property tax, business expenses is recommended. If you just dump everything into one file, you will have another major organizing task come April.

Tracking Expenses
Buy a notebook and keep it in your car. If you are doing charitable work, you can deduct miles to and fro. Keep good records of  the date, starting mileage, ending mileage, and the name and address of the charity. Keep track of business miles in the same manner. No more stressful guess work at tax time.  Also note the starting mileage on your odometer on January 1st and the ending mileage on December 31st. If you pay cash for parking meters while doing charitable works or business note those in your book too.

Know Your Cost Basis (purchase price of investments you buy)
Most brokerage companies track cost basis for you these days. But if you change brokerage company or advisor, it’s very wise to make sure you walk away with a document that lists cost basis for each investment. You need this data when you sell an investment. Maintain records of any improvements you do to your home as well. When you sell these costs will increase your basis (a good thing because it means you owe less tax).

Donating Items To Charity
Carefully itemize clothing, household goods, books, etc. that you give to your local Good Will, Salvation Army or other charity. Estimating a total dollar deduction is not enough. Do this before you drop the goods off, or you will forget what you gave away!

Calendar Important Dates
It’s so easy to forget to pay estimated taxes, especially if you are newly self-employed. When your taxes are not being deducted directly from your earnings you need to pay estimated taxes. The dates are April 15, June 15, September 15 and January 15. Set a calendar alert to yourself a week before so you have time to do the calculations. The best time to do tax planning is well before the calendar year is over: plan to do-it-yourself or meet with your tax advisor in October.

Tax Saving Tips

  • If you can hold on to a winning investment for more than one year, you will pay capital gains tax on the sale (currently at 15%) rather than your ordinary tax rate which can be significantly higher.
  • Buy income producing investments (i.e. bond funds or balanced funds) in retirement accounts rather than taxable accounts as the income from these investments is taxed at ordinary income tax rates not the lower capital gains rates.
  • Choose growth stock funds, individual stocks or tax-efficient mutual funds for your taxable accounts as they generate less or no current income.
  • If you have losses in your taxable account, you can sell them to offset gains in that account. Plus you can deduct $3000 in losses against your taxable income. You can buy back the investment if you want to as long as you follow the wash-sale rules.
  • Invest in a ROTH IRA if your income permits. You won’t get a tax deduction, but you won’t owe tax on withdrawal, ever.  (Special rules apply for earnings in Roth Accounts).
  • Save as much as you can in company retirement accounts. This money is tax-deferred and provides welcome tax relief in your highest earnings years. If you are self-employed take advantage of SEP IRA’s, Simple IRA’s or Defined Benefit plans. The type of plan you choose depends on your income and number of employees amongst other factors.
  • Consider converting some or all of your Individual IRA accounts to Roth IRA’s this year. For 2010, the income limitations are waived and you can spread the tax over two years if you choose.
  • State and Federal government’s occasionally provide tax credits. Unfortunately they all have different starting and expiration dates. Do a search on the IRS website www.irs.gov and your State’s tax board website to keep abreast of current credits. There are or have been credits for energy savings improvements to your home, childcare credits, first home buyer credits, education credits, etc.
  • Review your tax withholdings whenever your tax status changes. For example, when you get a pay raise (or pay cut), you buy a home, have a child, get married or get a divorce. The IRS has a tax withholding calculator or read IRS Publication 919 or ask your tax advisor for help.
  • If you buy mutual funds at the end of the year in your taxable account, research the date of any planned capital gain or dividend distribution first. You don’t want to buy a fund and get immediate taxable income before you have a chance to benefit from any investment gain. Buy after the distribution date.
  • Tax-payers in high tax brackets can benefit from buying muni-bond funds or bonds in their taxable accounts.  These investments earn federally tax-free and sometimes state tax-free income.  (Not beneficial for lower tax bracket individuals).

This isn’t an exhaustive list, but it’s a good start for most people. I hope these tips and strategies will help to make tax time less stressful and keep more money in your wallet!

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Curtis Financial Planning