| Tax Returns Can Help Achieve Financial Dreams |
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With tax returns completed and mailed, most people breathe a sigh of relief and forget about the IRS for another year. However, the information you gathered to satisfy Uncle Sam may be just what you need to begin realizing your financial dreams.
Developing a personal financial plan begins with accumulating much of the same data needed to prepare your income taxes. It is the perfect time to start on a financial plan. Taxpayers can use their income tax information to form the plan’s foundation.
First, you will need lists of assets and liabilities, copies of tax returns, insurance policies, wills, trusts and pension plans. This involves getting a handle on where you are in your financial life before you plan for where you want to be.
The second step in the financial planning process is identifying both financial and personal goals. The three objectives cited most often are security in retirement, providing for children’s education and developing an estate plan. While these are a little vague, they’re a start.
The third step is identifying problems that might prevent financial independence, such as too little or too much insurance, a high tax burden, inadequate cash flow or current investments that are losing money. It is important at this point to have a financial advisor assist in developing a plan.
A professional advisor can provide objectivity and expertise. It’s hard for people to be objective regarding their own finances, and most do not have the financial experience necessary to make wise decisions.
The fourth step is structuring a plan to meet financial needs and objectives, followed by implementation of agreed-upon recommendations. A financial advisor can help develop and implement the plan, but the decision to implement, modify or reject recommendations remains the individual’s ultimate responsibility. Many advisors provide a checklist to help clients implement their plans themselves.
A final, and often most important, step is periodically reviewing and revising the plan to account for changes in personal and economic conditions. The advisor and client can then review goals and problem areas and fine tune the plan as needed.
Be sure to check with your financial advisor how your tax return can serve as your starting point and progress report on achieving your financial planning goals. |
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| Dividing IRA Assets Upon Divorce |
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For many families, a significant portion of their wealth may be located within the couple's individual retirement accounts (IRAs). Should the family unit break down, it is therefore important to have an equitable and easy method to divide and transfer assets. Division of retirement assets can be a sticky problem and left to the court system. Yet, once a decree of divorce or separate maintenance is entered, the transfer of IRA assets from one spouse to another should not add further difficulty.
When an interest in an IRA is to be transferred from one spouse to another under a court decree, the Internal Revenue Service has attempted to facilitate as easy a transfer as possible. This accommodating position is most likely in response to the level of divorce in today's society. In general, the transferred interest in the IRA is viewed as the recipient-spouse's property and, therefore, this conveyance is acknowledged as tax-free. The IRS also offers two basic transfer methods to help during such a trying time.
The most common method is the direct transfer. The IRA owner-spouse may order the IRA trustee to transfer the necessary IRA assets directly to the trustee of a new or existing IRA in the name of the recipient-spouse. Another alternative is to transfer the assets the owner-spouse is entitled to keep to another IRA, leave the necessary amount in the old IRA for the recipient-spouse and change the name on this old IRA to that of the recipient.
This renaming method taken to its extreme is the second alternative recognized by the IRS. If all the assets in the owner-spouse's IRA are to be transferred to the recipient-spouse, a simple method of transfer is to just change the name of the account on the records of the financial institution. Sounds easy enough.
Given the inherent reporting problems, the sixty day rule, and the sometimes emotional environment of marriage dissolution, IRA rollovers are generally not permitted. Direct transfers by trustees are most often recommended. Of course, the most viable alternative will depend upon the particular situation and should be chosen with the advice of an attorney and financial advisor. |
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| Bankruptcy Alternatives |
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Fortunately, not all-financial difficulties result in bankruptcies. Financial problems are typically created when expenses and obligations consistently exceed income and the ability to make payments. Individuals can avoid a lot of grief by knowing some basic facts about the alternatives available to a person with serious financial difficulties.
The first step to repair your financial house is to make a simple statement showing the money that can be spared for loan payments and the total monthly payments that must be made. This statement will clearly reveal where you stand with respect to outstanding debts.
If normal debt service payments can no longer be made, an informal arrangement should be made with the creditor that can be settled out of court. Creditors may be willing to defer payments or refinance debt to reduce the size of monthly payments. If informal arrangements fail to resolve the overextended debt problem, it may be possible to find a lending agency that could arrange for lower monthly payments over a longer period of time.
The last step before filing for bankruptcy is the wage-earner plan, a form of debt consolidation allowed under Chapter XIII of the Federal Bankruptcy Act. Under this plan, with the guidance and protection of the Bankruptcy Court, and the assistance of an attorney, the debtor draws up a budget for paying all the debts along with meeting the normal living expenses for a period of three years. If this plan meets the approval of the court and creditors, interest and late charges on the debts are suspended. Each month the debtor turns over to a court trustee the predetermined installment payments for distribution to the creditor. The important feature of this plan is that the consumer does not give up any assets and a bankruptcy is not declared.
If you are having difficulty meeting your debt service payments or feel uncomfortable with your current level of debt, credit counseling may be in order. Such a service provides expert, confidential guidance for little or no charge. These services can be located through the National Foundation for Consumer Credit @ http://www.nfcc.org, 801 Roeder Road, Suite 900, Silver Spring, MD 20910 |
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| Life Insurance Don'ts |
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Life insurance can play an important part in an individual’s overall financial plan. Here are a number of common practical mistakes that could prove costly yet are easily avoided.
# 1 Naming the estate as beneficiary -- This brings the policy proceeds back into the probate estate where it will be subject to fees and expenses, inheritance taxes and creditor claims.
# 2 Failing to name backup beneficiaries -- Without backup beneficiaries, if the original named beneficiaries die first, it’s back to mistake #1. It might be a good idea to do this with other tools as well such as wills, trusts, and retirement plans.
# 3 Failing to do insurance policy check-ups -- It’s a pretty solid strategy to review policies every few years or so to look for changes in needs as well as changes in the family.
# 4 Mismatching the product with the problem -- Check-ups will often point out situations where there is the wrong type of policy for current needs, new types of policies may address needs better, or the old needs have changed.
# 5 Inadequate coverage for family security -- Family needs change over time. Analysis of survivor needs upon death or disability of a spouse, as well as the spouse’s expected lifestyle, could provoke policy updating.
# 6 Policy payable outright to minors -- Guardianship or custodian proceedings can be a burden for survivors. Look into a trust or a settlement option with restricted payouts to provide for minor children.
# 7 All life insurance owned by the insured -- Where there is a taxable estate, the insured might as well have named the IRS as a partial beneficiary. Getting it out of the estate through outright gifts or through a trust and then donating cash annually that can be used to pay remaining premiums can be a significant wealth preserver.
# 8 Not maximizing business-sponsored benefits -- Where individuals have some control over a small, closely held business, they should look into the cash flow and tax-effectiveness of the business providing the insurance. Consulting a professional in this area is a wise move.
# 9 Overusing term insurance -- Remember, term insurance runs out eventually while it also becomes more expensive. Re-evaluate needs and see if permanent products can address them better as time passes.
# 10 Buying life insurance as though a commodity -- Not all life insurance contracts are alike. The lowest price and the highest return do not necessarily mean it’s the best policy. Service and experience of the agent as well as strength of the company are more important.
Of course, the correct uses of life insurance can only be recommended with the help of a professional who can address the specifics of your particular financial situation. Be sure to contact your financial planner or life insurance professional to avoid these mistakes within your financial plan. |
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| Hope of a Lifetime May Provide Some Credit |
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The Taxpayer Relief Act of 1997 created a number of provisions designed to lighten the financial burden of higher education. Two new additions to the college-saving arsenal are the Hope credit and the lifetime learning credits.
The Hope credit is available to assist low- and middle-income families and students pay for post-secondary education. A tax credit up to $1,500 per year per student can be taken for each of the first two years of college. This amount consists of 100% of the first $1,000 of eligible expenses and 50% of the second $1,000 of eligible expenses.
The lifetime learning credit picks up where the Hope credit leaves off. It is available for the remaining years of college, graduate school and classes attended to acquire or improve job skills. There is a $2,000 maximum credit amount each year per family. The credit is calculated as 20% of the first $10,000 of eligible expenses.
Like the lifetime learning credit, the Hope credit may be claimed by the student or the parents. However, the Lifetime learning credit is available per family where the Hope credit is available per student. It is a distinction that is easily overlooked and may be a big difference when it comes to the total amount of potential assistance. Both of these credits are nonrefundable to the taxpayer, that is, the taxpayer can only reduce their tax liability to zero. This restriction may actually keep some taxpayers from using the full amount of the credit, especially if the family is able to claim other types of credits.
The ability to claim the Hope and lifetime learning credits are phased-out according to level of modified adjusted gross income (MAGI). The phaseout range for a single tax filer is between $43,000 and $53,000 (2005), and a joint filer’s phaseout range is between $87,000 and $107,000 (2005). Taxpayers whose MAGI exceeds these phaseout ranges are not able to utilize these credits. Individuals claiming married filing separately status may not claim either credit. Eligible taxpayers may claim the Hope and lifetime tuition credits in the same year that tax-free withdrawals for college expenses are made from a Coverdell Education Savings Account (ESA) or a 529 plan as long as the withdrawals aren't used for the same expenses that apply to the Hope or lifetime credit.
Qualified expenses are limited to tuition and fees. Unfortunately, room and board, books and supplies are not considered qualified expenses and, therefore, are not covered. To qualify for the Hope credit, the student must be enrolled on at least a half-time basis for at least one academic period during the year. But the lifetime credit can be claimed by a student who takes as little as a single course. The amount of eligible expenses are determined after scholarships and other forms of financial aid that are excludable from the student’s income are taken into account.
Of course, this brief article is no substitute for a careful consideration of all of the advantages and disadvantages of this matter in light of your unique personal circumstances. Before implementing an education planning strategy, contact and consult with your Financial Advisor and tax professional. |
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| Trustee Me |
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People of all shapes and sizes are establishing trusts. Credit shelter trusts, marital trusts, generation skipping trusts, life insurance trusts, charitable remainder trusts and living trusts, are just a few examples of the types of trusts that are in use today. All of these trusts have at least one thing in common--you need a trustee for all of them. The trustee plays an absolutely critical role in whether the trust will be successful. The question is, who should be the trustee?
Before answering this question, let's take a quick look at trusts. A trust is a written agreement between the grantor (sometimes called a settlor or trustor) and the trustee. Under a trust agreement, the grantor transfers cash and/or assets to the trustee and gives the trustee instructions regarding the distribution of the income and principal of the trust to the beneficiaries. The trustee is a fiduciary who must follow the instructions of the grantor with respect to the investment of trust assets and all distributions.
There are three types of trustees; professional, semi-professional, and amateur. Professional trustees are usually corporations who are engaged in the business of acting as a trustee for hire. Bank trust departments and independent trust companies are the most common examples of professional trustees. Semi-professional trustees are typically professional advisers like attorneys and accountants. These individuals have some, but perhaps not all, of the technical knowledge of a full-time professional trustee. However, they may have a long-standing relationship with the grantor and his/her family.
Amateur trustees include any individual who acts as a trustee on a part-time, infrequent basis. Appointing yourself, your spouse, your child, your brother-in-law the doctor or most other family and non-family members typically means that you have appointed an amateur trustee. Like any other aspect of financial planning, choosing a trustee involves weighing relative advantages and disadvantages and it should be done with the help of a lawyer.
Professional trustees do offer expertise in trust law, income taxes, investments and a variety of other topics that relate to trusts. Professional trustees also have staffs that can provide grantors and beneficiaries with various reporting services. There is very little risk of fraud when dealing with a corporate trustee and a corporate trustee won't die or become incapacitated. Professional trustees can also be expensive. In addition, the quality of service varies widely from institution to institution and even among branches of the same institution.
Semi-professional and amateur trustees share many of the same advantages and disadvantages, although perhaps to a different degree. On the plus side, they may be more "in tune" with the grantor's wishes and the personal needs of beneficiaries. They may waive some or all of the fee to which they are entitled. There are, of course, negatives as well. Semi-professionals and amateurs are part-time trustees. They may lack the skills necessary in complex situations. They are also subject to the human frailties of injury, sickness, death and dishonesty. There is no one right answer for all situations. It pays to review your options carefully. |
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| For Richer or Poorer |
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Every spousal financial relationship is unique. Through the years, couples develop their own systems for handling financial matters. Sometimes it is one partner’s responsibility to manage all finances, sometimes the other’s and sometimes a combination. Whatever the situation, certain information should be shared.
Couples should consider mutual responsibility for and knowledge of:
Retirement plans: Take time to fully acquaint each other with employer retirement benefits. Both partners should have current knowledge of pension plans, 401(k) accounts and IRAs. For a complete picture of expected retirement benefits, become familiar with each other’s Social Security benefits, as well. Understanding retirement benefit information will bring clarity and facilitate retirement planning.
Credit card documents: This one can be scary. Some may prefer to not know how much credit card debt their spouse has accumulated. But it’s wise to know where to find account numbers in case one loses his or her wallet and needs the other to help cancel the card. Also, mutual awareness of credit card debt amounts will help with developing a family’s overall financial plan.
Power of attorney: It is generally a good idea to have power of attorney on any individually owned assets, just in case one becomes ill or otherwise unavailable. Power of attorney can be limited to specific functions for a certain period, such as selling stocks or withdrawing money while traveling. A broad document that authorizes each partner to handle almost any situation in the other’s absence is also a consideration.
Wills, trusts and life insurance: It’s especially important to share information about wills, trusts and life insurance if either has been married before. There could be restrictions on how some assets may be used and beneficiaries left unchanged by mistake. Most important, make sure each partner knows where to find wills and will be able to easily access it if something were to happen.
Health insurance policies: Most insurance companies will cover care administered in the first 24 to 48 hours of a medical emergency, even if the coverage details have not been sorted out. But the situation isn’t as clear with hospital visits that are less urgent. If each partner is covered under a different insurance plan, both should be familiarized with the requirement “hoops” they may have to jump through.
If one spouse had a sudden illness, would the other know which doctor to call first to get an okay for treatment? If not, they risk running up big bills at an out-of-network doctor.
Business loans: If one spouse owns a business or is a partner in a professional firm, both should know about any personally guaranteed loans. It is critical to be aware of liabilities since household assets can be hit if the business can’t repay the loan.
While many don’t necessarily need to know everything about their spouse’s finances, maintaining a working knowledge of the above points can help maintain proper, balanced control over a family’s financial affairs. |
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| Does the Early Bird Get the Worm? |
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When people plan and invest for retirement, the decision of when to begin taking Social Security benefits eventually comes up. Social Security is an important source of retirement income for many individuals and, therefore, the decision of when to take these benefits can make a big impact on retirement income.
A retired worker who is fully insured can elect to start receiving benefits at any time between age 62 and 65 (or even later). Benefits can start as early as 62, but if you so elect they are permanently reduced by 20%. Here is where the question arises. Is it better to start taking checks at a reduced amount or wait until Normal Retirement Age and receive full benefits? Before addressing the inherent problems with this empirical question, let's look at some of the factors and considerations.
The early bird who decides to get the worm first gets three years' worth of checks -36 payments- that the sleeping bird will never see. Thus, it will take some time for the total benefits of the person who waits until age 65 to catch up to those of the early collector. Further, for those born after 1937, Normal Retirement Age is being extended. Normal Retirement Age is currently age 65, yet due to the Social Security amendments, full benefit age will be raised gradually in two stages until eventually reaching 67 in 2027. Thus, the early bird will receive even more checks than the retiree who bides his time for full benefits.
If the early bird also did not need the benefit income and chose to invest instead of spending the checks, the investment income would partially offset the reduced yearly benefit as well as extend the catch-up period for the age 65 collector. Sounds like most people would opt to be an early bird.
There are other factors to consider (as always). Working an extra three years will probably increase the patient retiree's benefits. This is so because more earnings will be credited toward the Social Security account. Chances are that old low-earning years will be replaced in the benefit equation with a current high credit year. These higher benefits will then shrink the catch-up period.
Delaying retirement benefits beyond 65 until age 70 will also increase the size of the benefit due to a credit provided by the Social Security Administration for such patience. Further, for those born after 1937 who choose to begin receiving benefits at age 62, the reduction-in-benefits penalty is further stiffened from 20% to an eventual 30% in 2022. The hare will feel the tortoise closing even quicker.
Taxation of benefits may also enter the picture. Poor timing of Social Security and other income may result in a good portion of early benefits being subject to inclusion in income and painfully taxed. On the other hand, a lower age 62 benefit may mean that the taxpayer will not meet the "combined income" threshold for benefits inclusion.
Empirical studies have been done which generally arrive at the same conclusion. Early bird collectors are ahead of the game for about 12 to 15 years and then are left behind the higher benefit collector. Thus, where a person is in good health and foresees another 10 + years of retirement life, it is probably better to defer taking benefits until normal retirement age. |
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| Kids Today |
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Kids can't vote. As if that wasn't already obvious, Congress really drove the point home in the 1986 Tax Reform Act with the creation of the so-called "kiddie tax." In spite of the rules having been around for almost a decade, many are still confused on this legislation.
The kiddie tax only applies to children under the age of 14. If your child reaches age 14 before the end of the calendar year, the tax does not apply for the entire year. Children over 14 are taxed, for the most part, like adults. The tax also applies only to "net unearned income." Net unearned income consists of taxable interest, dividends, capital gains, pension distributions, the taxable portion of social security benefits and taxable distributions from trusts. Earned income (e.g. paper route) is not subject to the special tax rules.
For 2005, the first $800 of net unearned income is not taxed. The next $800 is taxed at the child’s rate (most likely 10%). Net unearned income over $1,600 is taxed at the higher of the parent's rate or the child's rate. Clearly, the parent's rate will be the one that most frequently applies. The rate could be as high as 35%. If parents have more than one child under 14, the incomes of all are aggregated for purposes of calculating the tax at the parent's rate. The tax is then allocated between the children based on their incomes. Since the children's incomes are aggregated, the tax at the parent's rate can be pushed into the 28% marginal bracket or higher. Had the children's incomes been considered separately, this might not have happened.
Ordinarily, children file their own returns and attach Form 8615. By the way, just to show you that the IRS does have a sense of humor, the Service maintains that it takes only 55 minutes to prepare the form. Yeah, right.
Parents will have an election to include their children's unearned net income on their return. The election is made on Form 8814. To qualify, the following must be present: 1) the child must be under age 14 throughout the tax year, 2) the child's income must be solely from interest and dividends (mutual fund capital gain dividends qualify), 3) the child's income must be less than $8,000 (2004), 4) the child must not have made estimated tax payments (including any overpayment of tax from the prior tax year applied to the current year’s estimated tax), 5) there was no Federal income tax withheld from the child’s income, and 6) the child is required to file a tax return. The election may be made on the joint return of the parents. If the parents file separately, the election can only be made by the higher income parent.
For most parents, it probably makes more sense to file a separate return for the kids. Including the child's income will drive up the parent's adjusted gross income, making it less likely Mom and Dad will qualify for certain deductions and perhaps triggering certain deduction and exemption phase-outs. On the other hand, some parents may benefit from additional investment income if they have large investment interest expenses or from the child's capital gains if they have losses. |
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