Erickson Financial Solutions Blog
Reducing the taxing effect on your investments is a sure way to increase your rate of return without taking more risk,
Lending Money to a Family Member
Sometime in your life you may be asked to lend money to a family member – offspring or sibling. There are a few issues to consider. First, can you afford to loan the money and not get it back? Presumably whoever is borrowing the money could not get it elsewhere. If they have tried a bank and were turned down, perhaps the bank has a keener eye for success than you which suggests lending might not be a profitable idea and you may not get your money back.
But banks have been wrong before and you may wish to take a chance anyway. Now comes the issue of interest – what rate will you charge.
As long as the loan is for $10,000 or less, there won't be a problem. However, if the borrowed amount is larger and you do not charge the going rate of interest, the IRS will "impute" interest for you, based on its own assumptions. You'll end up being treated as if you had charged/earned interest, even though you hadn't, and you'll owe tax on that "phantom income" that you didn't receive.
If lending to an offspring, special rules may apply. If the loan is for $100,000 or less, the interest you will be considered to have received annually for tax purposes is limited to the amount of your child's net investment income for the year. And if that amount doesn't exceed $1,000, you can avoid taxable interest income on the intra-family loan. But the IRS may still intercede if it suspects that you're trying to dodge the tax liability.
How do you figure out what the "going rate" for interest is? It depends on several factors, including the type of loan, its length, and the interest rates in your local area. You might be able to charge slightly less than a local bank, but you can't go overboard.
What happens if you do not get paid back? The IRS could determine that the "loan" was always meant to be a gift. To avoid that problem, it's best to have an attorney draft a formal loan document. It should include the usual terms that would be found in a bank loan. For instance, the document will usually indicate:
· The amount of the loan;
· The time allowed for repayment;
· The interest rate structure;
· A description of the collateral securing the loan.
Finally, have the loan document witnessed and notarized. This is the best proof you can have if the IRS ever challenges the deal. Also, keep records showing repayments to demonstrate that the arrangement is a bona fide loan.
This article was written by Steven Erickson based upon material prepared by a professional financial journalist for Erickson Financial Solutions, LLC and is not intended as legal or investment advice.
ETFs Can Provide Some Genuine Benefits To Investors
ETFs may sound like aliens from the "Star Wars" movies. But they're actually an increasingly popular investment in Missouri and across the nation that offers several potential benefits to investors. The acronym stands for exchange-traded fund. And if you don't already have ETFs in your portfolio, you might want to consider adding some to the mix to provide diversification at a low cost.
ETFs are securities that normally track an index, such as the well-known Standard & Poor's (S&P) 500. They are traded on a public stock exchange, so prices fluctuate throughout each trading day. Because of this liquidity, and the fact that fees associated with the investment are typically reasonable, more investors are opting for ETFs.
Technically, the ETF owns underlying assets—such as stocks, bonds, commodities, or foreign currencies—and this ownership is divided into shares for investors. Therefore, you own the ETF's investments indirectly and your shares represent their market value. Also, any ETF may have dozens or hundreds of underlying securities thereby giving you exposure to many securities rather than just one bond or one stock. Another advantage is the ETFs provide tax advantages in that the typical ETF does not trade its component share as often as standard mutual funds.
What's more, ETFs let you diversify across a wide range of underlying investments, while providing investors with other advantages such as being able to buy short or on margin. And taxable gains aren't passed through to shareholders, although you will be taxed on any gains under the usual rules when you sell an ETF. Lastly, the composition of the ETF changes little year-to-year which means what you buy remains much what it was while you own it. This is unlike a mutual fund that may alter its components considerably even in one year.
We can help you determine whether this investment "creature" is suitable for your situation.
Article rewritten by Steven Erickson from an article provided by Advisor Products.
How You Can Manage Risk Aversion
During the early part of 2017, the stock market was rolling merrily along, with the Dow Jones Industrial Average (DJIA) breaking through the 20,000-point barrier for the first time. Whether the "Trump bump" will fast is anyone's guess, but and some prognosticators are forecasting eventual doom and gloom. In all likelihood, the stock market will continue to experience ups and downs, just like it has throughout its history. The question is what risks are you taking.
Regardless of whether the market is going up or down, or staying relatively stable, your portfolio should reflect your personal aversion to risk. Primarily, there are three types of risk to address in this overall philosophy:
1. Risk of loss of principal: This is the risk of losing the money you initially invested. Say you buy a stock for $1,000 that jumps to $1,200 before it falls back to $900. If you sell the stock at that point, you will have lost $100 of principal.
2. Risk of loss of purchasing power: You may be willing to limp along with modest returns, but you're losing money if the inflation rate exceeds your rate of return. For instance, if you acquire a bank CD paying a 2% annual rate and inflation rises to 3.5%, you're losing 1.5% in the purchasing power of that investment.
3. Risk of outliving your savings: Is your investment plan overly conservative? Remember that the stock market historically has outperformed most comparable investments over long periods, although there are no absolute guarantees. Therefore, you're likely to fare better with a well-devised investment plan than you would if you stuffed your money under a mattress. Otherwise, you might outlive your savings, especially given recent increases in life expectancies.
Risk assessment surveys can provide some insights. Typically, an analysis will reveal that you tend to be either a conservative, moderate, or aggressive investor, within certain ranges. Your portfolio should reflect this characterization.
If you are not able to endure the swings in the market, you may want to fine-tune your investments accordingly, taking into account asset allocation and diversification methods. Again, these strategies do not offer any guarantees, nor do they protect against losses in declining markets, but they remain fundamentally sound.
Other potential ideas are to weight your portfolio more heavily to bonds than you did in your younger days. The technique of "bond laddering," with bonds maturing at different dates, is a variation on this theme. Similarly, conservative investors may emphasize dividend-paying stocks and blue chips, as well as mutual funds and exchange traded funds (ETFs) offering diversification.
Every situation is different. Reach out to us to address your specific concerns.
Material in this article was written by a professional financial journalist for Erickson Financial Solutions, LLC and is not intended as legal or investment advice. © 2017. All Rights Reserved.
Time Your Social Security Benefits For Top Results
What's the payoff for working most of your life and paying Social Security tax into the system? When your time to retire finally comes, you'll be eligible to receive Social Security benefits based on your work history and when you choose to begin receiving benefits. If you're married, you may have additional options for Social Security, even if one spouse has worked little or not at all.
Your basic options for receiving benefits are to start early, begin benefits at your full retirement age (FRA), or to delay benefits until later.
- You can begin receiving Social Security retirement benefits as early as age 62, but if you do, you'll lock in smaller benefits than you would have gotten if you'd waited longer. If you retire at age 62, your benefit will be about 25% lower than if you waited until FRA.
- If you wait until FRA (also called "normal retirement age") to apply for benefits, there's no reduction. Your FRA depends on the year in which you were born. For most post-World War II Baby Boomers, the age is 66. However, FRA increases gradually and tops out at age 67 for those born after 1960.
- Finally, if you postpone your benefits until after FRA, you'll receive an increased monthly payment. For each year you wait, you'll get about 8% more, until you reach age 70. (Waiting past 70 doesn't increase your benefit amount.)
These basic rules apply to individuals. If you're married, you can claim benefits based on your own work record or you can get 50% of the benefit your spouse is entitled to, if that's higher.
Because Social Security benefits are guaranteed for life, starting early with a smaller benefit still could deliver significant income over your remaining years. Yet you may collect more overall if you start later or if you live for a long time. According to the Social Security Administration (SSA) the average life expectancy of someone at age 65 is now 84.3 years for a male and 86.6 years for a female.
What should a married couple do? Every situation is somewhat different, but consider these three common scenarios:
Scenario 1. Adam and Eve are close in age and income. Because they're both in good health and enjoy their jobs, they plan on working past FRA. They also have enough savings, plus their work income, to sustain them easily until age 70. Currently, Adam has a life expectancy of age 88, while Eve's is age 90. If they elect early benefits at age 62, they would be entitled to an estimated lifetime benefit of almost $1.25 million. But if they wait until age 70 to apply for benefits and then live as long as expected, they could receive close to $125,000 more.
Scenario 2. In our next example, Romeo and Juliet have shorter life expectancies due to health issues. Currently, Romeo has a life expectancy of age 78 and Juliet has a life expectancy of age 76. If they claim benefits at FRA, it's estimated that the couple will receive almost $100,000 more than if they delayed benefits until age 70, based on their life expectancies.
Scenario 3. Jack and Jill are both in their early sixties. Jill is in better health than Jack. If they start benefits at age 62, let's say Jack would get $1,500 a month and Jill $750 per month. Those amounts would rise to $2,000 monthly for Jack and $1,000 for Jill if they claim benefits at FRA. However, by delaying benefits until age 70, Jack will receive about $2,650 a month. What's more, if Jill outlives Jack as expected, she is entitled to benefits based on 50% of Jack's higher monthly amount. Depending on how long Jill lives, her total benefits easily could increase by $50,000 or even more.
One of these scenarios might be similar to your situation, but you'll need to factor in your own variables—including how long you want to or need to work, as well as other financial and personal considerations and your health status—as you consider the best times for you and your spouse to begin receiving Social Security benefits.
© 2017. All Rights Reserved.
IRS Reveals The "Dirty Dozen" Tax Scams For '17
The IRS has released its annual list of the "Dirty Dozen" tax scams to watch out for in 2017. Here's a recap of the IRS' summary of the top 12:
1. Phishing: A scammer may pose as a representative of an organization you know and trust, perhaps sending mass emails under another person's name or purporting to be a bank, credit card company, tax software provider, or government agency. The goal is to get you to provide personal information.
2. Phone Scams: Crooks may make aggressive phone calls when impersonating an IRS agent. The person might threaten you with police arrest, deportation, license revocation, or some other action—which legitimate agency employees wouldn't do.
3. Identity Theft: Watch out for identity theft, especially during tax-filing season, when someone might steal your Social Security number and use it to file a tax return, claiming a fraudulent refund.
4. Return Preparer Fraud: The vast majority of tax professionals provide honest, high-quality service. But some dishonest preparers perpetrate refund fraud, identity theft, and other scams.
5. Fake Charities: Look out for groups masquerading as charitable organizations to attract donations from unsuspecting contributors. Be wary of charities with names similar to familiar or nationally known organizations. Take a few extra minutes to ensure your hard-earned money goes to legitimate and currently eligible charities. Visit IRS.gov to check out their status.
6. Inflated Refund Claims: Promoters may offer exorbitant refunds. Be wary of anyone who asks taxpayers to sign a blank return, promises a big refund before looking at their records, or charges fees based on a percentage of the refund. Fraudsters rely on flyers, advertisements, phony storefronts—even word of mouth via community groups—to find victims.
7. Excessive Claims for Business Credits: The fuel tax credit—which isn't available to most taxpayers and usually is limited to off-highway business use, including farming—often is claimed improperly. Taxpayers also should avoid misuse of the research credit. Claims for that credit may be disqualified for failure to participate in or to substantiate qualified research activities or to satisfy tax law requirements.
8. Falsely Padding Deductions on Returns: Avoid the temptation to falsely inflate deductions or expenses on returns to pay less than what you owe or to get a bigger refund. Think twice before overstating deductions such as charitable contributions and business expenses or improperly claiming credits such as the Earned Income Tax Credit (EITC) or Child Tax Credit (CTC).
9. Falsifying Income to Claim Credits: Avoid the temptation to inflate deductions or expenses on your return to underpay taxes and possibly receive a larger refund. Overstating deductions for charitable contributions and business expenses or claiming invalid personal credits could lead to large bills for back taxes, interest, or even criminal prosecution.
10. Abusive Tax Shelters:Abusive tax schemes have evolved from illegal domestic and foreign trust arrangements into even more sophisticated strategies. These scams often take advantage of the financial secrecy laws of some foreign jurisdictions and the availability of credit or debit cards issued from offshore financial institutions.
11. Frivolous Tax Arguments: The IRS also describes common frivolous tax arguments made by those who refuse to comply with federal tax laws. Frequently, taxpayers refuse to pay taxes on religious or moral grounds by invoking their First Amendment rights. Those efforts inevitably fail, and the penalty for filing a frivolous tax return is $5,000.
12. Offshore Tax Avoidance: A recent string of successful enforcement actions against offshore tax cheats and the financial organizations that help them shows why it's a bad bet to hide money and income offshore. Taxpayers are served best by coming in voluntarily and taking advantage of the IRS Offshore Voluntary Disclosure Program to catch up on their tax responsibilities.
© 2017. All Rights Reserved.
When financial advisors explain the reasons to invest in, or not invest in, particular stocks, they often refer to the "fundamentals" of the companies in question. Media pundits also may cite "fundamentals" in their stock prognostications. And corporate officers may brag about their companies' "fundamentals."
But what does it all mean? They're generally referring to fundamental analysis, a traditional school of thought in looking at companies' basic numbers as a way to evaluate profitability.
Unlike technical analysis of a company, which focuses on the recent trading and pricing history of the company's stock, fundamental analysis paints a broad picture of a company. This process identifies the fundamental value of the shares and leads to decisions to buy or sell the stock.
With technical analysis, you're trying to spot patterns that will help predict whether the fortunes of a company will rise or fall. In contrast, fundamental analysis involves profit margins, management decisions, growth potential, balance sheets, a company's role in a specific industry or sector, and political and other events, domestically and globally, that might affect its performance.
But fundamental analysis isn't limited to figuring out which stocks to buy and when to buy them. It is also about analyzing the timing of possible sales or purchases.
For example, when the stock market is booming, as it was at the start of 2017, investors are quick to jump on the bandwagon, while during times of stock market decline, the same investors often flee in a panic. That's what happened in 2008 and 2009, when the economy contracted and share prices fell by more than half. Of course, there are times when it makes sense to sell stocks, but it is best not to base such decisions on fear.
A better idea is to take a closer look at the fundamentals. In doing so, you might ask—and get answers to—these questions after a market decline has pushed down the price of a particular holding:
- Is the business model still solid?
- Have profit margins remained consistent?
- Is the company financially sound?
- Is the company likely to thrive over time?
If the answers are "yes," you may be well-served to retain your shares in the company for the long term. However, if the firm appears to be heading in the wrong direction, has shrinking profit margins, and sports a business model that is out of touch with changes in the industry, you probably should sell sooner rather than later.
Of course, you don't have to pour through financial reports and other documents to guide your decisions. If you invest in mutual funds, their professional managers are doing this work for you, analyzing company fundamentals to help them decide what to buy or sell to maximize their funds' performance. And we routinely help clients investigate stock fundamentals as they shape their portfolios. Please give us a call if you'd like to discuss your current and potential holdings.
For more information, contact a fiduciary, fee-only adviser in Columbia or Jefferson City Missouri.
Timely Tax Angles To Dividends
Not all payouts to shareholders are "qualified dividends," but those that are get favorable treatment in which they're normally taxed at less than your rate for ordinary income.
But the tax rules for qualified dividends may go out the window if proposed tax reforms are enacted. The big question is whether you would fare worse under the new rules—or better.
Under current law, most dividends issued by domestic companies are qualified when paid out to shareholders and the owners of mutual funds. In some cases, qualified dividends also may come from foreign corporations, if their shares include publicly traded American Depositary Receipts (ADRs) or shares that are otherwise readily available on an established U.S. securities market.
The maximum tax rate on qualified dividends is only 15% for most investors. If you're in the top ordinary income tax bracket of 39.6%, the tax rate is 20%. Even better, though, investors in the two lowest ordinary income brackets of 10% and 15% benefit from a maximum 0% rate on qualified dividends.
To qualify for these reduced tax rates, shareholders of common stock and mutual funds must own the shares for more than 60 days, including the ex-dividend date (the annual date on which dividends are paid out). The holding period is 90 days for preferred stock. This can affect the timing of transactions if the ex-dividend date is approaching.
Other dividends, including most dividends issued by foreign corporations, are taxed at ordinary income rates. Therefore, if you received $1,000 in foreign dividends in 2016 and you're in the top tax bracket of 39.6%, you must pay $396 in tax on the dividends on your 2016 tax return. But even then, you may be eligible for a foreign credit or deduction that can offset tax paid on foreign dividends dollar for dollar.
So how does potential tax reform figure in the mix? Under campaign proposals from President Trump, the favorable tax rates for qualified dividends would be repealed, but investors would benefit from overall tax cuts. The seven-bracket structure would be scaled back to just three tax brackets with a top tax rate of 33%. It's not yet clear what changes will be enacted, however, or how particular taxpayers might fare.
The best approach is to continue to monitor developments. We will pass along vital information.
This article was written by a professional financial journalist for Erickson Financial Solutions, LLC of Columbia and Jefferson City and is not intended as legal or investment advice.
© 2017. All Rights Reserved.
17 Midyear Tax Moves You Still Can Make In '17
Winds of tax reform are blowing in Washington, but nothing has happened yet. In the meantime, take advantage of tax breaks currently on the books, including these 17 items:
1. Capital losses: If you realized capital gains from securities sales earlier this year, you can start harvesting losses. Your losses will go to offset capital gains you realize in 2017 plus up to $3,000 of highly taxed ordinary income.
2. Capital gains: Long-term capital gains that aren't offset by losses will be taxed at a maximum rate of only 15% (20% if you're in the top ordinary income tax bracket). But some upper-income investors also may owe a 3.8% tax on investment income.
3. 401(k) contributions: Reduce your tax liability by boosting contributions to a 401(k) plan. For 2017, the maximum deferral is $18,000 ($24,000 if age 50 or over). Not only do you avoid tax on the contributions, the money in your account compounds on a tax-deferred basis.
4. Roth conversions: This may be a good time to convert funds in a traditional IRA to a Roth. Future Roth IRA distributions are tax-free if they meet certain conditions. And though you'll owe income tax on the amount you convert, transferring the funds over several years could reduce the overall tax bite.
5. Higher education: Is your child going to college in the fall? Generally, you can claim one of two higher education tax credits, subject to phaseouts based on income. A tuition deduction, also off-limits to most high-income families, expired after 2016 but could be revived.
6. Monetary gifts: If you give money to charities this year—by check, credit card, or online—the donation generally is deductible in 2017. But you must observe strict recordkeeping requirements for charitable gifts of $250 or more.
7. Wash sales: If you acquire substantially identical securities within 30 days of taking a loss on a sale, you can't deduct the loss. Avoid this "wash sale" rule by waiting at least 31 days to buy back the same securities—or you might buy the securities first and wait at least 31 days before selling the original shares.
8. Dividend-paying stocks: Most stock dividends are taxed at the same preferential tax rates as long-term capital gains. To qualify for this tax break, you must hold the shares for at least 61 days.
9. Installment sales: Generally, you can defer tax on the sale of real estate or other property if you receive payments over two years or longer. Besides stretching out tax payments, you might reduce the effective tax rate if you stay below the thresholds for higher capital gains rates and the 3.8% tax.
10. Hiring your child: Does your child need a summer job? If you hire the child to work at your business, the wages are deductible by the business and taxable to your child at his or her low tax rate.
11. Qualified small business stock: If you invest in qualified small business stock (QSBS) of a fledgling company (perhaps your own) and hold it for at least five years before selling it, you can exclude 100% of any gain.
12. Vacation homes: When you rent out your vacation home, you can write off specified rental activity costs, plus depreciation, but be careful: If your personal use of the rental home exceeds the greater of 14 days or 10% of the days the home is rented out, deductions are limited to the amount of your rental income.
13. Dependency exemptions: Generally, you can claim a $4,050 dependency exemption for a child graduating from college this spring if you provide more than 50% of the child's annual support. Figure out the amount needed to clear the half-support mark.
14. Charitable gifts of property:Give furniture and clothing in good condition to charity. You normally can deduct the fair market value of property donated to a qualified organization, within certain limits.
15. Dependent care credit: If you pay expenses for the care of your under-age-13 child this year while you (and your spouse, if married) work, you may qualify for the dependent care credit. Note that the cost of summer day camp qualifies, but not overnight camp.
16. Like-kind exchanges: If you swap investment or business real estate you own for like-kind property, the exchange is tax-free, except to the extent you receive any "boot" (e.g., additional money) in the deal. Caution: The IRS imposes timing requirements for this tax break.
17. Estimated taxes: Check to see if you're withholding enough income tax from your paychecks. Make necessary adjustments to avoid owing an "estimated tax penalty" in 2017.
This article was written by a professional financial journalist for Erickson Financial Solutions, LLC and is not intended as legal or investment advice.
© 2017. All Rights Reserved
16 Of The Best Tax Moves For The Summer Of '16
Now that the Protecting Americans from Tax Hikes (PATH) Act has removed some of the uncertainty, tax planning during the summer of 2016 should be a breeze. Here are 16 tax-saving opportunities that may be available to you midway through the year:
1. Capital losses: If you cashed in stock winners earlier in the year, you can start filling up the loss side of the ledger. Your capital losses will completely offset capital gains that you realize in 2016, plus up to $3,000 of highly taxed ordinary income.
2. Capital gains: Meanwhile, if you sell securities and earn what qualify as long-term capital gains, the maximum tax rate is only 15% or 20% if you're in the top ordinary income tax bracket. But some upper-income investors also may have to pay a surtax of 3.8% on investment income.
3. Higher education: Is your child going to college in the fall? Lay the groundwork for tax breaks. You may be able to claim a higher education tax credit or a tuition deduction, though these tax advantages are phased out at relatively modest income levels. The PATH Act restores the tuition deduction and makes the American Opportunity tax credit permanent.
4. Wash sales: If you acquire substantially identical securities within 30 days of selling an investment at a loss, you can't deduct the loss. But this "wash sale" rule can be avoided by waiting at least 31 days to buy back the same securities. Or you could buy the additional securities first and wait at least 31 days before selling your original shares.
5. Dividend-paying stocks: Most stock dividends are taxed at the same preferential tax rates as long-term capital gains. To qualify for this tax break, you must hold the shares for at least 61 days.
6. Installment sales: Generally, you can defer tax on the sale of real estate or other property if you receive payments over two years or longer. Besides stretching out tax payments over time, you might reduce the effective tax rate if you stay below the thresholds for higher capital gains rates and the 3.8% surtax.
7. Hiring your child: Does your child need a summer job? If you hire the child to work at your business, your business can deduct the wages, which will be taxable to your child at his or her low tax rate.
8. 401(k) contributions: Reduce your tax liability by increasing contributions to a 401(k) plan at work. For 2016, the maximum deferral is $18,000 ($24,000 if you're 50 or older). Not only do you avoid tax on the contributions, the money in your account compounds tax-deferred until you withdraw it, probably during retirement.
9. Qualified small business stock: Invest in qualified small business stock (QSBS) of a fledgling company (perhaps your own). The PATH Act restores a 100% tax exclusion for sales of QSBS if you hold the stock at least five years before selling it.
10. Roth IRA conversions: You can convert some or all of the funds in a traditional IRA to a Roth. In return for paying income tax on the converted amount, future Roth IRA distributions will be tax-free if they meet certain conditions. To minimize the current tax impact, you could stagger taxable conversions over several years.
11. Vacation homes: You can write off certain rental activity costs, plus depreciation, but be careful: If you use the rental home for more than 14 days or for 10% of the days the home is rented out, whichever is greater, your deductions are limited to the amount of your rental income.
12. Dependency exemptions: You probably still can claim a $4,000 dependency exemption for a child graduating from college in 2016 if you provide more than 50% of the child's annual support. Figure out the amount needed to put you over the half-support mark.
13. Charitable gifts of property: Don't toss out old furniture and clothing; give items in good condition to charity. Generally, you can deduct the fair market value of property donated to a qualified organization, within certain limits.
14. Conservation easements: A special tax provision allows you to claim deductions for donating conservation easements involving property you own. Under the PATH Act, you can deduct up to 50% of your adjusted gross income (AGI) this year (100% for farmers and ranchers) instead of the usual 30%-of-AGI limit.
15. Day camps: If your under-age-13 children attend a day camp while you (and your spouse, if married) work this summer, you may qualify for the dependent child care credit. However, the cost of overnight camp isn't eligible.
16. Estimated taxes: Check to see whether you're withholding enough income tax from your paychecks and adjust the amount if necessary to avoid owing an "estimated tax penalty" in 2016.
This article was written by a professional financial journalist for Advisor Products and is not intended as legal or investment advice.
© 2016, all rights reserved.
Study These Six Higher Education Tax Breaks
Paying for college can be daunting, but federal tax rules provide some relief. With enhancements from the Protecting Americans from Tax Hikes (PATH) Act of 2015, you may benefit from one or more of these six tax provisions:
1. Section 529 Plans, available from all 50 states and the District of Columbia, encourage families to set aside savings for future education expenses. Most states set contribution limits at $300,000 or more. Generally, the investment grows without current taxes and distributions to pay for most college expenses — including tuition, fees, books, supplies, equipment, and room and board for full-time students — are completely tax-free.
You can choose a 529 plan from any state, and although college-savers often choose to save in the plan of their home state, you might be better off establishing a plan elsewhere. Still, more than half of the states offer state tax deductions or credits for Section 529 plan contributions by residents. That could be a compelling reason to stay home when choosing a plan.
2. The American Opportunity Tax Credit (AOTC) became a permanent tax break when the PATH Act became law in December 2015. The maximum annual credit is $2,500. You can get separate credits for each qualified student in your family. For example, if you have three kids in school this year, your maximum credit is $7,500. Also, under another recent tax law change, you now can claim the AOTC for up to four years of school for each child, up from two years previously.
However, the AOTC phases out between $80,000 and $90,000 of modified adjusted gross income (MAGI) for single filers and $160,000 to $180,000 for joint filers. Once you exceed the upper limit, you can't claim the AOTC.
3. The Lifetime Learning Credit (LLC) also is a permanent part of the tax code, but the maximum credit of $2,000 applies per taxpayer rather than per student. So even if you have three kids in school at the same time, the maximum credit is still $2,000.
And eligibility for the LLC also phases out, at levels lower than the AOTC. The range in 2016 is between $55,000 and $65,000 of MAGI for single filers and from $111,000 to $131,000 for joint filers.
4. Tuition deductions also permit some parents to claim deductions for tuition and related fees paid to colleges and universities. This tax provision, extended through 2016 by the PATH Act, provides a deduction of either $4,000 or $2,000, depending on MAGI. For single filers, the $4,000 deduction is available for a MAGI up to $65,000 and $2,000 between $65,000 and $80,000. Joint filers can deduct $4,000 for a MAGI up to $130,000 and $2,000 if a MAGI is between $130,000 and $160,000. Above those limits you don't get a deduction. Taxpayers may claim either higher education credit—the AOTC or the LLC—or the tuition deduction, but not more than one of these three tax breaks.
5. Student loan interest deductions allow you to deduct the annual interest you pay on a student loan, up to a maximum of $2,500. This deduction applies only to the taxpayer who's actually repaying the loan. And the deduction for student loan interest is phased out based between $65,800 and $80,000 of MAGI for single filers and between $130,000 and $160,000 of MAGI for joint filers.
6. Coverdell Education Savings Accounts (CESAs) allow annual contributions of up to $2,000. This is on the low side, especially when compared to Section 529 plans that let you make six-figure contributions. And the ability to put money into a CESA in the first place is phased out between $95,000 and $115,000 of MAGI for single filers and between $190,000 and $220,000 of MAGI for joint filers. But if you qualify, these accounts, too, shield you from current taxes on earnings and you can withdraw money tax-free to pay for tuition and fees, room and board, uniforms, transportation, books and supplies, academic tutoring, and computers.
These tax breaks may offer parents help in saving for the high cost of higher education. We can help you sort through your options and navigate the arcane rules to find the best path in your situation.
© 2016, all rights reserved.
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Four Retirement Planning Rules Of Thumb To Bend
The online Merriam-Webster dictionary offers two definitions for "rule of thumb":
- A method or procedure based on experience and common sense,
- A general principle regarded as roughly correct but not intended to be scientifically accurate.
In other words, although rules of thumb can be useful guidelines, they're not gospel on any particular issue. This is especially important to remember when you're trying to set aside enough money to last comfortably through your retirement years. And while some traditional rules of thumb that have been followed faithfully for decades may serve as starting points, they're not infallible. Consider these four examples:
1. Save one million dollars for retirement. How much will you and your spouse need to live on in retirement? That's the age-old question. In recent years, some people have seized on a million dollars as the magic number to strive for. It's a nice round figure and, after all, can't a millionaire afford an upscale lifestyle in retirement?
But a million dollars doesn't go as far as it used to. Suppose you take an income of 4% of your savings annually—another rule of thumb for using retirement savings (see below). That's just $40,000 a year, and there will be even less if you dig into your nest egg to buy a winter "snowbird" home, for example, or take a few exotic vacations. And people are living longer these days, so you may need money to sustain you for 25 or 30 years, not 20 or less.
Another option that can be used is to set aside an amount roughly equal to eight times your ending salary (or even higher). So, if you're pulling down $200,000 just before retirement, you should have $1.6 million (8 x $200,000) in your coffers. That may be a preferable goal—but even then, a 4% withdrawal will give you only $64,000 a year.
2. Replace 80% of your pre-retirement income. This rule of thumb has been amended to make some concessions for a higher cost of living. Previous estimates often were predicated on replacing 70% or 75% of your salary with savings from retirement plans at work and IRAs, investment earnings, Social Security benefits, and other sources. Again, this rule of thumb may work for some people, but not for everyone, and replacing 80% of a high salary could require very substantial savings. You want to have 80% of that $200,000 in income? That's $160,000 a year, and could require savings of $4 million or more.
Moreover, the 80% rule ignores certain variables, such as health-care needs, lifestyle choices, and family obligations. It may be more helpful to go beyond rules of thumb to estimate what your expenses really may be in retirement and work backward to figure out how much you will have to accumulate and earn annually to meet your objectives.
3. Save at least 10% of your income for retirement. The old belief is that you should pay yourself first before you pay anyone else. This rule of thumb mandates that you set aside at least 10% of your salary each year no matter what is happening in your life. For a simplified example, if you earn $150,000 a year and thus set aside $15,000 a year in a tax-deferred vehicle such as a 401(k) plan, you will have $1,470,081 after 30 years if you earn an annual 7% return. (This example is hypothetical and not indicative of any particular investments.)
There are two problems here. First, there's no guarantee that saving 10% a year will give you what you need in retirement. The second is that it may be difficult to maintain that discipline, especially if you're raising a family during your peak earning years. If your saving lags during those years or if you can't start saving until later in life, the 10% rule is very likely to give you less than you need.
4. Withdraw no more than 4% annually from your nest egg. At first blush, this principle makes perfect sense for anyone planning on a long lifetime in retirement. In theory, if you withdraw 4% a year and earn more—say, 7% or 8%, as a hypothetical example—you should be able to sustain your nest egg throughout retirement as long as inflation remains relatively low.
But there are no guarantees of what interest rate you will earn, and you might have to use more than 4% some years. Furthermore, during a sharp market downturn, taking out even the minimum 4% could put you in a deeper hole that could be hard to dig out of.
Where do you stand? Although these four guidelines can be helpful, a better idea is to work out a comprehensive plan for your future. We would be glad to provide the retirement planning assistance you need.
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