Wealth Clarity Blog

Our good friends over at Kovarik & Kim, CPAs have published their latest tax epistle, and we have scoured it for nuggets of wisdom.  Dan and Scott’s focus on high net worth individuals makes this an annual must read.  As in recent years, we have forwarded it in its entirety so you can consume as much or as little as you want.  Don’t be bashful!

2011 Year-End Tax Planning Letter 

Without taking anything away from their letter, I have attempted to highlight a few of the morsels that caught my attention. 

1.)    Bush-era tax cuts will expire in one year if Congress does nothing, which unfortunately has become a regular pattern.  What this means is that tax planning is even more complicated than normal because you have to think about the current year, and next year, and the unknown future impacts.

2.)    Make charitable gifts from your IRA.  Unfortunately, this assumes you are older (specifically over 70 ½), but within certain limits you can get very important resources to your favorite charities in a tax efficient manner.  Timing is everything on this because the benefit turns into a pumpkin at the end of the year.

3.)    Convert Traditional IRAs to Roth.  Somewhat oldie but goodie.  With the ability to have a “do over” if the timing of the decision doesn’t work out, and the elimination of the income requirements, should make this one of the most sought after financial gifts under the tree this year.   

4.)    If you are in the 1% (whether you admit it or not), it has never been easier to give money away and incur less Federal estate tax (or no tax in some cases).  Exemptions are at a plump $5 million through 2012, and tax rates are a bargain at 35%. 

5.)    Healthcare reform has some tax provisions that will start in 2013 and need to be considered.  Surtaxes on investment income and additional Medicare taxes for high income earners, to name a few, will be material to various financial decisions. 

As K&K conclude, this isn’t the time to take matters into your own hands and navigate this complex web alone.  In my opinion, there is no substitute for hiring a qualified tax professional as part of your financial advisory team.

Happy Holidays!

As we are heading into the typical year end giving season, fraught will all kinds of traditional philanthropic complexity, I wanted to pass along a lesson I have learned in my own giving: 

Consciously checking my motives to make sure the giving is about the give-ee (recipient) and not about the give-or (me and you). 

There are plenty of examples of wealthy families and individuals that give large gifts to get recognition in some form, or their name on a building, or control the impact of the gift. I find it easy to dismiss those actions as:  I would never do that because I’m not that egotistical or narcissistic!

I wish all my giving was altruistic but realistically it’s just not the case; however, there are a bunch of subtle issues, that when I’m really honest with myself, influence how and why I give. 

For example, there are times the giving is about making me feel good; wanting to be in control, gaining approval from someone, and being seen as significant.  The dark side of giving takes roots in these quiet moments of reflection where only “I” can judge my true intentions and motivations. 

One check and balance to apply to your giving is to consider making more of your gifts in the purest form = anonymous.  Gifts in this form can take away the control and impact I want to bundle together with my gift.

Another possibility is to embrace the planting and harvesting giving concept.  Using this clearly farming metaphor, there are times when the gift is about planting and we may not be able to see the fruits of our giving for many reasons.  In other instances, someone else may have contributed greatly to the early stages of planting and we get the blessing of seeing our gift bear all kinds of fruit.  I have found the more I try to control whether I’m a planter or a harvester, or both, the more the giving becomes about me.

Finally, before you write any checks–or gift appreciated securities–this year end, take the following quick emotional inventory:

1. Am I okay if I don’t get recognition for the gift?
2. Am I more concerned about the person or organization in need or the giver? 
3. Should this gift be made anonymously?
4. Am I okay not controlling the outcome or the harvest, instead being one of many to move the ball further down the field?

What other giving issues or emotional effects of giving have you experienced that could be helpful to share?

Guest post by Colleen Kroeger, Director of Client Care

Looking for a way to be smart and stay positive (at least from an attitude perspective) in the current market situation?  

Now may be a good time to consider both sides of the Roth IRA conversion coin:  if you did a full or partial conversion in 2010 and lost substantial market value afterward, you may want to recharacterize your conversion back to a traditional IRA; likewise, if you’ve delayed converting your IRA to Roth, you may want to consider converting for the 2011 tax year.  

Recharacterization

Recharacterization – “undoing” your Roth conversion – is an option to consider if the amount converted declined in value during the year.  The deadline for recharacterizing a 2010 Roth conversion is October 17, 2011. 

A unique tax planning option was offered to individuals who converted to Roth IRAs in 2010: taxpayers could spread the associated tax over 2011 and 2012.  However, the decision to recharacterize gets tricky if you elect this option and only plan to recharacterize a portion of your original conversion.  If you intended to spread the tax from your 2010 conversion over 2011 and 2012, the only way to do so if you recharacterize is to re-convert half in 2011 and half in 2012.  There is some risk of re-converting at higher values with market volatility so high, potentially undoing the value of recharacterizing in the first place. Keep in mind if you recharacterize, you need to wait 30 days to re-convert. 

Some of our clients converted to Roth IRAs during 2010.  In response to the market’s volatility we recently compared the conversion amounts to the current values. The change in values since conversion ranged from approximately -6% to +5%.  Because of continued market volatility, we found that it may not be valuable to consider recharacterization unless the converted amount dropped more than 10%.  Although our ultimate recommendation for those clients was to not recharacterize their conversions, the exercise sparked meaningful and valuable conversations with our clients, allowing them to understand the strategic relationship between this tax “tail” and the investment “dog.” 

Conversion

With many accounts posting negative returns year to date, now may be a good time for a partial or full conversion. Taxes due from a conversion are dependent on a number of things including investment earnings and deductible contributions. Just make sure you have adequate cash on the sidelines for the tax bill due in April 2012. 

We suggest you consult with your wealth and tax advisors if you are considering either of these strategies. For additional ideas, take a look at this interesting article.

Contrary to the common approach of taking Social Security early, I’ve found that after running hundreds of financial plans, it’s often best to wait. 

The primary reasons people start early is the assumption they can earn better returns than the government or believe they might as well take what they can before entitlement reform kicks in.   While this is reasonable, the decision to take benefits early comes with steep lifetime benefit cuts that increases their risk of outliving their money.   This is further complicated by increasing life expectancies due to medical advancements.  By transferring more of the longevity risk to the government, retirees may find they can go into their later years with more confidence.

Most pundits believe social security reforms will focus on younger workers and won’t impact people who are near or in retirement.  Anything is possible but this makes sense due to the political difficulties of reducing benefits on this influential voting bloc.  One reason high net worth individuals might take benefits early is the risk they could be “means tested” in the future.  However, the potential benefit of starting early if this happened may not provide enough reward to offset the permanently reduced benefits that come with this decision.

With all this in mind, I’ll touch on three potential mistakes I see retirees make:

1)      Taking Benefits Too Early.  70% of retirees take benefits earlier than their normal retirement age.  Age 62 is the earliest you can start and the lifetime benefit reduction is 25%.  One rationale for taking early is you can earn returns on the money you receive; pushing the break-even age (compared with waiting) to the early 80’s if you do well.  What happens if you live past 80?  The life expectancy of a 62 year old female is 86.

2)      Not Considering Joint Life Expectancy.  Upon death, the surviving spouse’s benefit (if lower) jumps to the deceased spouses benefit.  If the husband has a higher benefit, there is a real planning opportunity due to lower male life expectancy.  The husband can wait until 70 to take benefits and receive 32% more compared to starting at 66, while his bride can start her benefits at 62.  If the husband dies first, she can step up to his higher benefit for the rest of her life.  This is especially powerful if the husband is older than his wife. 

3)      Triggering the “Earnings Penalty.”  You temporarily lose $1 of benefit for every $2 of “earned income” over $14,160 if you take benefits before full retirement age, which can be a bad cash flow surprise.  You eventually get this back but it isn’t worth the rigmarole and tax headache.  If you are working part time after you retire from your full time job, it’s best to wait until full retirement age to start Social Security.

From a planning perspective, it’s good to look at scenarios assuming full and reduced benefits to see the implications.  The best age to start is unique to each retiree’s situation and depends on health and a host of other factors.  If you have recently signed up and want to reconsider, the good news is you can change your mind within the first twelve months. 

Due to the fact this is a very complex area, please don’t hesitate to contact me if you have additional questions.

Employee stock options can be a great way to achieve substantial wealth.  The difficulty is it can disappear quickly if not addressed properly. 

Something that has really dawned on me after helping executives with these decisions over many market cycles, is that option wealth is usually a once in a lifetime event.  Not realizing this, many executives place more emphasis on where they think the stock will go than on their long term goals.  This is further complicated by the general excitement they can have for a company they founded or helped build to be very successful.

Recently, I was helping an executive that had the majority of their net worth in options think through the issues.   I thought it might be helpful to list some key questions we reviewed that would be relevant to anyone in this fortunate, yet complex situation.

1)      Does the current after tax value of the options allow you to be financially independent today?  If so, it may mean it’s time to take risk off the table to secure the future.  If not, you may want to let run since you are still in wealth accumulation mode.

2)      What are the tax implications?  With some stock options, you can pay less tax if you exercise and hold the stock for at least a year.  With others, there’s no tax benefit to waiting.

3)      What are the risks of exercising and holding?  The risks are often higher than the benefits.  Upon exercise, there may be taxes.   If the stock declines, you’ll still be on the hook for the taxes.  Also, the expected return of the stock would need to be sufficiently high to offset the concentrated holding risk.

4)      Who is affected by this decision and how are they impacted?  When you explore this question, you might realize it’s more than just your family.  For example, if you have philanthropic goals, there may be many people beyond your family that will be impacted.

5)      Has your lifestyle expenses increased ahead of exercising the options?  It’s important to realize option wealth isn’t real until the options have been exercised and sold.  Up until that point, the wealth is on paper and subject to considerable concentrated holding risk.  If your current lifestyle is dependant on the current option value, it’s crucial to take some risk off.

The decision points around stock options can be complex, but they are surmountable.  Since future option values are so unpredictable, finding the time to formulate a strategy around realizing the option wealth is essential. 

If you would like me to address other issues about employee stock options, feel free to drop me a line.

If you missed our webinar earlier this month, you’re in luck!  Click this link for playback of the Preserving, Protecting, and Enhancing Wealth in the New Normal webinar. Slides, audio, and tips.

Sorry you missed the ‘live’ webinar, we’ll let you know when our next one will be.  In the meantime, do you have any questions or feedback for us?

Below is another very helpful tax missive from our friends at Kovarik and Kim CPAs detailing many of the anticipated tax changes coming our way at the end of this year.  You might remember that the Bush-era tax cuts will be expiring on 12/31 if Congress doesn’t act before then.  In addition, the new Healthcare Reform legislation signed into law by President Obama will also usher in another slew of tax changes (read “increases”).  The real impact will be on the higher income and wealthier individuals. 

The high points in summary are as follows:

1. When fully phased in, the top long-term capital gains rate could climb from 15% to 23.8% including applicable surtaxes, and ordinary dividends will no longer have preferential treatment.
2. Regular marginal tax rates will increase from 35% to 39.6%.
3. Shifting income into 2010 could be an interesting tax planning strategy to review in light of the changing future environment. Continue Reading »

I was meeting with a client recently and she asked if there was a listing of wealth management best practices; something to review and use as a tool to enhance her efficiency in managing and thinking about her wealth.  The more I thought about her request I realized that this could be a useful idea for my wealth creating readers.  So, Jodi, this one’s for you…and everyone else too. 

1. Have a “Plan B.”  Significant market changes can create scenarios where your best laid plans no longer work.  Are you ready to deal with that potential?  Stress testing your estate plan and other strategies using contingency planning is critical. 
2. Have a copy of your financial plan where you can find it.  It should include the names and contact information of your key advisors and professionals.
3. Review your cash flow and net worth statements at least annually.  Look for trends, concentrations, liquidity levels, lifestyle costs.
4. Schedule time for a complete review of your estate plan and insurance coverage at least every three years.
5. Review your financial goals every two years. Are they still relevant? Have you accomplished them already? Do you need some new ones?  What do you want your life story to be in the coming months/years?

For the full list of 15 in greater detail, subscribe to the blog, shoot me an email (info@highlandcm.com) and I’ll send you the 15 secrets.  For those of you already subscribing, let me know and I’ll send the list to you as well.  Just our little way of giving back.

 There have been some major changes to the federal estate tax laws this year.

Laws passed several years ago went into effect recently and repealed the federal estate tax on January 1, 2010, and then will reinstate it in 2011 under very different rules.  Our legal friends at Howard Rice have created an excellent summary of the issue and potential considerations.

In short, 2010 is an interesting transition period where nobody has clarity about what to do because it was widely expected Congress would have implemented some type of permanent legislation by now.  It’s still possible something will be enacted later this year, and it may be applied retroactive to January 1. 

In fact, I was an attendee at the 54^th Annual Washington State Bar Association Estate Planning Seminar this past fall that was attended by well over 500 attorneys, CPAs, and other professional advisors.  A show of hands from this room full of professionals overwhelmingly predicted that Congress would take action before the end of 2009 to “fix” this issue, if for no other reason than because the U.S. Government needs the tax receipts.  It just goes to show you that even the legal community is having a difficult time gauging the direction this will ultimately go.

At this time, there continues to be quite a bit of speculation regarding how it will get resolved.  All of this uncertainty means there could be interesting planning opportunities, depending on your circumstances. 

It is very important that you review any estate planning strategies with your attorney before taking any action.

It’s not often that wealth creators and high-income earners get a break when it comes to taxes, but it appears we’ll have one of those rare opportunities in January 2010.

There was a relatively little-publicized provision in a 2005 federal tax law that eliminates the income restrictions on the conversion of IRAs to Roth IRAs, and it goes into effect January 1.

Our friends over at Kovarik and Kim, CPAs have done a good job summarizing the benefits of Roth conversion and which financial scenarios might make the most sense.

Roth IRA Rollover

In short, the key points to be aware of are:

1. Roth IRAs are considered to be a better savings vehicle (versus their IRA brethren) because of the tax free growth, tax-free withdrawals, and no required minimum distributions at age 70 1/2, among other things.
2. The previous income limits are eliminated starting in 2010.  Typically, if your adjusted gross income (AGI) exceeded $100,000 for a married couple filing joint, you weren’t able to take advantage of the conversion.
3. If you income is low in 2010, you could potentially convert all or a portion of these assets at a low incremental federal tax impact.  Even if your income isn’t low, and depending on your circumstances, there could be strong incentive for converting now.
4. You can effectively unwind the transaction if done before the filing of your 2010 tax return, in the case where the financial markets declined after conversion.  In addition, you can defer the tax on the conversion over a two-year period.

As always, make sure to consult your CPA before taking any action of this kind to confirm that you understand all of the implications and costs.