As 2016 draws to a close, there is still time to reduce your 2016 tax bill and plan ahead for 2017. This letter highlights several potential tax-saving opportunities for you to consider. I would be happy to meet with you to discuss specific strategies.
As a general reminder, there are several ways in which you can file an income tax return: married filing jointly, head of household, single, and married filing separately. A married couple, which includes same-sex marriages, may elect to file one return reporting their combined income, computing the tax liability using the tax tables or rate schedules for “Married Persons Filing Jointly.” If a married couple files separate returns, in certain situations they can amend and file jointly, but they cannot amend a jointly filed return to file separately. A joint return may be filed even though one spouse has neither gross income nor deductions. If one spouse dies during the year, the surviving spouse may file a joint return for the year in which his or her spouse died. Certain married persons who do not elect to file a joint return may be entitled to use the lower head of household tax rates. Generally, in order to qualify as a head of household, you must not be a resident alien, you must satisfy certain marital status requirements, and you must maintain a household for a qualifying child or any other person who is your dependent, if you are entitled to a dependency deduction for that person.
Basic Numbers You Need to Know
Because many tax benefits are tied to or limited by adjusted gross income (AGI)—IRA deductions, for example—a key aspect of tax planning is to estimate both your 2016 and 2017 AGI. Also, when considering whether to accelerate or defer income or deductions, you should be aware of the impact this action may have on your AGI and your ability to maximize itemized deductions that are tied to AGI. Your 2015 tax return and your 2016 pay stubs and other income- and deduction-related materials are a good starting point for estimating your AGI.
Another important number is your “tax bracket,” i.e., the rate at which your last dollar of income is taxed. The tax rates for 2016 have not changed from 2015 and are 10%, 15%, 25%, 28%, 33%, 35% and 39.6%. Although tax brackets are indexed for inflation, if your income increases faster than the inflation adjustment, you may be pushed into a higher bracket. If so, your potential benefit from any tax-saving opportunity is increased (as is the cost of overlooking that opportunity).
Annual Gift Tax Exclusion: The most commonly used method for tax-free giving is the annual gift tax exclusion, which, for 2016, allows a person to give up to $14,000 to each donee without reducing the giver's estate and lifetime gift tax exclusion amount. A person is not limited as to the number of donees to whom he or she may make such gifts. Further, because the annual exclusion is applied on a per-donee basis, a person can leverage the exclusion by making gifts to multiple donees (family and non-family). Thus, if an individual makes $14,000 gifts to 10 donees, he or she may exclude $140,000 from tax. In addition, because spouses may combine their exclusions in a single gift from either spouse, married givers may double the amount of the exclusion to $28,000 per donee. A person may not carry over his or her annual gift tax exclusion amount to the next calendar year. Qualifying tuition payments and medical payments do not count against this limit.
IRA, Retirement Savings Rules
Tax-saving opportunities continue for retirement planning due to the availability of traditional and Roth IRAs and other retirement savings incentives.
Traditional IRAs: Individuals who are not active participants in an employer pension plan may make deductible contributions to an IRA. The annual deductible contribution limit for an IRA for 2016 is $5,500. For 2016, a $1,000 “catch-up” contribution is allowed for taxpayers age 50 or older by the close of the taxable year, making the total limit $6,500 for these individuals. Individuals who are active participants in an employer pension plan also may make deductible contributions to an IRA, but their contributions are limited in amount depending on their AGI. For 2016, the AGI phase-out range for deductibility of IRA contributions is between $61,000 and $71,000 of modified AGI for single persons (including heads of households), and between $98,000 and $118,000 of modified AGI for married filing jointly. Above these ranges, no deduction is allowed.
In addition, an individual will not be considered an “active participant” in an employer plan simply because the individual's spouse is an active participant for part of a plan year. Thus, you may be able to take the full deduction for an IRA contribution regardless of whether your spouse is covered by a plan at work, subject to a phase-out if your joint modified AGI is $184,000 to $194,000 ($0 - $10,000 if married filing separately) for 2016. Above this range, no deduction is allowed.
IRA Rollovers: As of 2016, taxpayers may make only one IRA-to-IRA rollover per year. (Direct rollovers from trustee to trustee are not affected.) An attempted rollover after the first will be treated as a withdrawal and taxed at regular rates, plus a possible 10% early withdrawal penalty.
Spousal IRA: If an individual files a joint return and has less compensation than his or her spouse, the IRA contribution is limited to the lesser of $5,500 for 2016 plus age 50 catch-up contributions ($1,000 for 2016), or the total compensation of both spouses reduced by the other spouse's IRA contributions (traditional and Roth).
Roth IRA: This type of IRA permits nondeductible contributions of up to $5,500 for 2016, but no more than an individual's compensation. Earnings grow tax-free, and distributions are tax-free provided no distributions are made until more than five years after the first contribution and the individual has reached age 591/2. Distributions may be made earlier on account of the individual's disability or death. The maximum contribution is phased out in 2016 for persons with an AGI above certain amounts: $184,000 to $194,000 for married filing jointly, and $117,000 to $132,000 for single taxpayers (including heads of households); and between $0 and $10,000 for married filing separately who lived with the spouse during the year.
Roth IRA Conversion Rule: Funds in a traditional IRA (including SEPs and SIMPLE IRAs), §401(a) qualified retirement plan, §403(b) tax-sheltered annuity or §457 government plan may be rolled over into a Roth IRA. Such a rollover, however, is treated as a taxable event, and you will pay tax on the amount converted. No penalties will apply if all the requirements for such a transfer are satisfied.
If you already made a conversion earlier this year, you have the option of undoing the conversion. This is a useful strategy if the investments have gone down in value so that if you were to do the conversion now, your taxes would be lower. This is a complicated calculation and we should meet to determine what are your best options.
In addition, for 2016, if your §401(k) plan, §403(b) plan, or governmental §457(b) plan has a qualified designated Roth contribution program, a distribution to an employee (or a surviving spouse) from such account under the plan that is not a designated Roth account is permitted to be rolled over into a designated Roth account under the plan for the individual.
401(k) Contribution: The §401(k) elective deferral limit is $18,000 for 2016. If your §401(k) plan has been amended to allow for catch-up contributions for 2016 and you will be 50 years old by December 31, 2016, you may contribute an additional $6,000 to your §401(k) account, for a total maximum contribution of $24,000 ($18,000 in regular contributions plus $6,000 in catch-up contributions).
SIMPLE Plan Contribution: The SIMPLE plan deferral limit is $12,500 for 2016. If your SIMPLE plan has been amended to allow for catch-up contributions for 2016 and you will be 50 years old by December 31, 2016, you may contribute an additional $3,000.
Catch-Up Contributions for Other Plans: If you will be 50 years old by December 31, 2016, you may contribute an additional $6,000 to your §403(b) plan, SEP or eligible §457 government plan.
Saver's Credit: A nonrefundable tax credit is available based on the qualified retirement savings contributions to an employer plan made by an eligible individual. For 2016, only taxpayers filing joint returns with AGI of $61,500 or less, head of household returns with AGI of $46,125 or less, or single returns (or separate returns filed by married taxpayers) with AGI of $30,750 or less, are eligible for the credit. The amount of the credit is equal to the applicable percentage (10% to 50%, based on filing status and AGI) of qualified retirement savings contributions up to a maximum credit of $2,000.
Required Minimum Distributions: For 2016, taxpayers who are at least 701/2 must take their required minimum distribution from IRAs or defined contribution plans (§401(k) plans, §403(a) and §403(b) annuity plans, and §457(b) plans that are maintained by a governmental employer). The distribution must be taken by December 31, 2016. However, if you turn 70 1/2 during 2016, the first distribution is not required until April 1, 2017.
Maximize Retirement Savings: In many cases, employers will require you to set your 2017 retirement contribution levels before January 2017. But, if you did not elect the maximum 401(k) contribution for 2016, you may be able to increase your amount for the remainder of 2016 to lower your AGI in order to take advantage of some of the tax breaks described above. Maximizing your contribution is generally a good tax-saving move.
Deferring Income to 2017
If you expect your AGI to be higher in 2016 than in 2017, or if you anticipate being in the same or a higher tax bracket in 2016, you may benefit by deferring income to 2017. Deferring income will be advantageous so long as the deferral does not bump your income to the next bracket. Deferring income could be disadvantageous, however, if your deferred income is subject to §409A, thus making the income includible in gross income and subject to additional tax. Some ways to defer income include:
Delay Billing: If you are self-employed and on the cash-basis, delay year-end billing to clients so that payments will not be received until 2017.
Interest and Dividends: Interest income earned on Treasury securities and bank certificates of deposit with maturities of one year or less is not includible in income until received. To defer interest income, consider buying short-term bonds or certificates that will not mature until next year. If you have control as to when dividends are paid, arrange to have them paid to you after the end of the year.
Accelerating Income into 2016
In limited circumstances, you may benefit by accelerating income into 2016. For example, you may anticipate being in a higher tax bracket in 2017, or perhaps you will need additional income in order to take advantage of an offsetting deduction or credit that will not be available to you in future tax years. Note, however, that accelerating income into 2016 will be disadvantageous if you expect to be in the same or lower tax bracket for 2017. In any event, before you decide to implement this strategy, we should “crunch the numbers.”
If accelerating income will be beneficial, here are some ways to accomplish this:
Accelerate Collection of Accounts Receivable: If you are self-employed and report income and expenses on a cash basis, issue bills and attempt collection before the end of 2016. Also see if some of your clients or customers might be willing to pay for January 2017 goods or services in advance. Any income received using these steps will shift income from 2017 to 2016.
Year-End Bonuses: If your employer generally pays year-end bonuses after the end of the current year, ask to have your bonus paid to you before the end of 2016.
Retirement Plan Distributions: If you are over age 591/2 and you participate in an employer retirement plan or have an IRA, consider making any taxable withdrawals before 2017.
You may also want to consider making a Roth IRA rollover distribution, as discussed above.
Deduction timing is also an important element of year-end tax planning. Deduction planning is complex, however, due to factors such as AGI levels, AMT, and filing status. If you are a cash-method taxpayer, keep the following in mind:
Deduction in Year Paid: An expense is only deductible in the year in which it is actually paid. Under this rule, if your tax rate is going to increase in 2017, it is a smart strategy to postpone spending until after year end to take the deduction in 2017.
Payment by Check: Date checks before the end of the year and mail them before January 1, 2017.
Promise to Pay: A promise to pay or providing a note does not permit you to deduct the expense. But you can take a deduction if you pay with money borrowed from a third party. Hence, if you pay by credit card in 2016, you can take the deduction even though you won't pay your credit card bill until 2017.
AGI Limits: For 2016, the overall limitation on itemized deductions (“Pease” limitation) applies to taxpayers whose AGI exceeds an “applicable amount.” For 2016, the applicable amount is $311,300 for a married couple filing a joint return or a surviving spouse, $285,350 for a head of household, $259,400 for an unmarried individual, and $155,650 for a married individual filing a separate return. In addition, certain deductions may be claimed only if they exceed a percentage of AGI: 10% for medical expenses (7.5% for certain older taxpayers), 2% for miscellaneous itemized deductions, and 10% for casualty losses.
Standard Deduction Planning: Deduction planning is also affected by the standard deduction. For 2016 returns, the standard deduction is $12,600 for married taxpayers filing jointly, $6,300 for single taxpayers, $9,300 for heads of households, and $6,300 for married taxpayers filing separately. As you can see from the numbers, for 2016, the standard deduction for married taxpayers is twice the amount as that for single taxpayers. If your itemized deductions are relatively constant and are close to the standard deduction amount, you will obtain little or no benefit from itemizing your deductions each year. But simply taking the standard deduction each year means you lose the benefit of your itemized deductions. To maximize the benefits of both the standard deduction and itemized deductions, consider adjusting the timing of your deductible expenses so that they are higher in one year and lower in the following year. You can do this by paying in 2016 deductible expenses, such as mortgage interest due in January 2017.
Medical Expenses: For 2016, medical expenses, including amounts paid as health insurance premiums, are deductible only to the extent that they exceed 10% of AGI. Unless extended by Congress, 2016 is the last year the special 7.5% limitation applies for taxpayers age 65 or older.
State and Local Income Taxes and General Sales Taxes: If you anticipate a state income tax liability for 2017 and plan to make an estimated payment most likely due in January, consider making the payment before the end of 2016. Or, you may elect to itemize and deduct state and local general sales taxes in lieu of the itemized deduction for state and local income taxes on your 2016 return.
Charitable Contributions: Consider making your charitable contributions at the end of the year. This will give you use of the money during the year and simultaneously permit you to claim a deduction for that year. You can use a credit card to charge donations in 2016 even though you will not pay the bill until 2017. A mere pledge to make a donation is not deductible, however, unless it is paid by the end of the year. Note, however, for claimed donations of cars, boats and airplanes of more than $500, the amount available as a deduction will significantly depend on what the charity does with the donated property, not just the fair market value of the donated property. If the organization sells the property without any significant intervening use or material improvement to the property, the amount of the charitable contribution deduction cannot exceed the gross proceeds received from the sale.
To avoid capital gains, you may want to consider giving appreciated property to charity.
Regarding charitable contributions please remember the following rules: (1) no deduction is allowed for charitable contributions of clothing and household items if such items are not in good used condition or better; (2) the IRS may deny a deduction for any item with minimal monetary value; and (3) the restrictions in (1) and (2) do not apply to the contribution of any single clothing or household item for which a deduction of $500 or more is claimed if the taxpayer includes a qualified appraisal with his or her return. Charitable contributions of money, regardless of the amount, will be denied a deduction, unless the donor maintains a cancelled check, bank record, or receipt from the donee organization showing the name of the donee organization, and the date and amount of the contribution.
A special provision gives taxpayers the ability to distribute tax-free to charity up to $100,000 from a traditional or Roth IRA maintained for an individual who has reached age 701/2.
Equipment Purchases: If you are in business and purchase equipment, you may make a “section 179 election,” which allows you to expense (i.e., currently deduct) otherwise depreciable business property. The allowable deduction is $500,000 (with a phaseout beginning at $2,010,000).
In addition, careful timing of equipment purchases can result in favorable depreciation deductions in 2016. In general, under the “half-year convention,” you may deduct six months worth of depreciation for equipment that is placed in service on or before the last day of the tax year. (If more than 40% of the cost of all personal property placed in service occurs during the last quarter of the year, however, a “mid-quarter convention” applies, which lowers your depreciation deduction.) Cars/vans/trucks are typically limited in the amount of first-year expensing/depreciation. If bonus depreciation is not claimed, the limit is $3,160 for 2016 ($3,560 in the case of vans and trucks). If bonus depreciation is taken, the 2016 amounts increase to $11,160 for cars and $11,560 for vans and trucks. A popular strategy in recent years is to purchase a vehicle for business purposes that exceeds the depreciation limits set by statute (i.e., a vehicle rated over 6,000 pounds). Such vehicle would qualify for the full equipment expensing dollar amount. However, for SUVs (rated more than 6,000 but not over 14,000 pounds gross vehicle weight) the expensing amount is limited to $25,000.
NOL Carryback Period: If your business suffers net operating losses for 2016, you generally apply those losses against taxable income going back two tax years. Thus, for example, the loss could be used to reduce taxable income—and thus generate tax refunds—for tax years as far back as 2014. Certain “eligible losses” can be carried back three years; farming losses can be carried back five years.
Bonus Depreciation: Bonus depreciation under §168(k) for assets purchased and placed in service in 2016 is available; you must elect out of bonus depreciation if you do not wish to take advantage of it.
Capitalization v. Expensing for Materials and Supplies and Repairs: Under regulations, a deduction is allowed for materials and supplies that have an acquisition or production cost of $200 or less. Also, a de minimis safe harbor states that for repairs to be deductible, among other requirements, the unit of property must cost less than $5,000 per invoice or item substantiated by the invoice for taxpayers with applicable financial statements and $2,500 per invoice for taxpayers without applicable financial statements.
Education and Child Tax Benefits
Child Tax Credit: A tax credit of $1,000 per qualifying child under the age of 17 is available on this year's return. In order to qualify for 2016, the taxpayer must be allowed a dependency deduction for the qualifying child. Another qualifying determination is that the qualifying child must be younger than the taxpayer. The credit is phased out at a rate of $50 for each $1,000 (or fraction of $1,000) of modified AGI exceeding the following amounts: $110,000 for married filing jointly; $55,000 for married filing separately; and $75,000 for all other taxpayers. These amounts are not adjusted for inflation. A portion of the credit may be refundable. The threshold earned income level to determine refundability is set by statute at $3,000.
Credit for Adoption Expenses: For 2016, the adoption credit limitation is $13,460 of aggregate expenditures for each child, except that the credit for an adoption of a child with special needs is deemed to be $13,460 regardless of the amount of expenses. The credit ratably phases out for taxpayers whose income is between $201,920 and $241,920.
Education Credits: The American Opportunity Tax Credit is available for qualified tuition and fees paid on behalf of a student (i.e., the taxpayer, the taxpayer's spouse, or a dependent) who is enrolled on at least a half-time basis. The maximum credit is $2,500 (100% on the first $2,000, plus 25% of the next $2,000). The credit is available for the first four years of the student's post-secondary education. The credit is phased out at modified AGI levels between $160,000 and $180,000 for joint filers, and between $80,000 and $90,000 for other taxpayers. Forty percent of the credit is refundable, which means that you can receive up to $1,000 even if you owe no taxes. The term “qualified tuition and related expenses” includes expenditures for “course materials” (books, supplies, and equipment needed for a course of study whether or not the materials are purchased from the educational institution as a condition of enrollment or attendance). One way to take advantage of the credit for 2016 is to prepay spring 2017 tuition. In addition, if you know what books your student will need for the spring 2017 semester, those can be bought in 2016 and the costs qualify for the credit for 2016.
The Lifetime Learning credit maximum in 2016 is $2,000 (20% of qualified tuition and fees up to $10,000). A student need not be enrolled on at least a half-time basis so long as he or she is taking post-secondary classes to acquire or improve job skills. As with the American Opportunity Tax Credit, eligible students include the taxpayer, the taxpayer's spouse, or a dependent. For 2016, the Lifetime Learning credit is phased out at modified AGI levels between $111,000 and $131,000 for joint filers, and between $55,000 and $65,000 for other taxpayers.
Coverdell Education Savings Account: The aggregate annual contribution limit to a Coverdell education savings account is $2,000 per designated beneficiary of the account. The limit is phased out for individual contributors with modified AGI between $95,000 and $110,000 and joint filers with modified AGI between $190,000 and $220,000. The AGI amounts are not indexed for inflation. The contributions to the account are nondeductible but the earnings grow tax-free.
Student Loan Interest: You may be eligible for an above-the-line deduction for student loan interest paid on any “qualified education loan.” The maximum deduction is $2,500. The deduction for 2016 is phased out at a modified AGI level between $130,000 and $160,000 for joint filers, and between $65,000 and $80,000 for individual taxpayers.
Kiddie Tax: The kiddie tax applies to: (1) children under 18 who do not file a joint return; (2) 18-year-old children who have unearned income in excess of the threshold amount, do not file a joint return, and who have earned income, if any, that does not exceed one-half of the amount of the child's support; and (3) children between the ages of 19 and 23 if, in addition to the above rules, they are full-time students. A parent may elect to include a child's gross income in the parent's gross income and to calculate the “kiddie tax.” One of the requirements for the parental election is that a child's gross income is more than $1,050 but less than $10,500 for 2016. If a child has more than $2,100 for 2016 in interest, dividends, and other unearned income, and the income is not or cannot be reported on a parent's return by filing Form 8814, part of that income may be taxed to the child at the parent's tax rate instead of the child's tax rate.
Achieving a Better Life Experience (ABLE) Accounts: This is a relatively new type of savings account for individuals with disabilities and their families. For 2016, taxpayers can contribute up to $14,000. Distributions are tax-free if used to pay the beneficiary's qualified disability expenses.
Residential Energy Efficient Property Credit: Tax incentives are available to taxpayers who install certain energy efficient property, such as photovoltaic panels, solar water heating property, fuel cell property, small wind energy property and geothermal heat pumps. A credit is available for the expenditures incurred for such property up to a specific percentage, except that a cap applies for fuel cell property. Unless extended by Congress, the credit for qualified fuel cell power plants, qualified small wind energy property, and qualified geothermal heat pump property expires on December 31, 2016. If you have made improvements to your home or plan to by the end of 2016, please contact me to discuss the amount of the credit you may qualify for.
Nonbusiness Energy Property Credit: Taxpayers may claim a nonrefundable nonbusiness energy property credit for qualified residential energy efficiency improvements installed during the tax year and residential energy property expenditures paid or incurred during the tax year. Such property includes qualified windows, insulation, boilers, hot water heaters, and circulating air fans. Each type of property has its own dollar limits, with a cumulative total lifetime limit of $500. However, unless extended by Congress, such property must be installed by the end of 2016.
Small Employer Pension Plan Startup Cost Credit: For 2016, certain small business employers that did not have a pension plan for the preceding three years may claim a nonrefundable income tax credit for expenses of establishing and administering a new retirement plan for employees. The credit applies to 50% in qualified administrative and retirement-education expenses for each of the first three plan years. However, the maximum credit is $500 per year.
Employer-Provided Child Care Credit: For 2016, employers may claim a credit of up to $150,000 for supporting employee child care or child care resource and referral services. The credit is allowed for a percentage of “qualified child care expenditures” including for property to be used as part of a qualified child care facility, for operating costs of a qualified child care facility and for resource and referral expenditures.
Work Opportunity Credit: The work opportunity credit is an incentive provided to employers who hire individuals in groups whose members historically have had difficulty obtaining employment, including the long-term unemployed. This gives your business an expanded opportunity to employ new workers and be eligible for a tax credit against the wages paid.
The following rules apply for most capital asset transactions in 2016:
• Capital gains on property held one year or less are taxed at an individual's ordinary income tax rate.
• Capital gains on property held for more than one year are taxed at a maximum rate of 20% (0% if an individual is in the 10% or 15% marginal tax bracket; 15% for individuals in the 25%, 28%, 33% and 35% brackets).
An additional 3.8% tax is levied on certain unearned income. The tax is levied on the lesser of net investment income or the amount by which modified AGI exceeds certain dollar amounts ($250,000 for joint returns and $200,000 for individuals). Investment income is: (1) gross income from interest, dividends, annuities, royalties, and rents (other than from a trade or business); (2) other gross income from any business to which the tax applies; and (3) net gain attributable to property that is not attributable to an active trade or business. Investment income does not include distributions from a qualified retirement plan or amounts subject to self-employment tax. This rule applies mostly to passive businesses and the trading in financial instruments or commodities. With this additional tax, the maximum net capital gains rate is 23.8% in 2016. Because distributions from qualified retirement plans are not subject to the tax, taxpayers may want to invest in retirement accounts, if possible, rather than taxable accounts.
Timing of Sales: You may want to time the sale of assets so as to have offsetting capital losses and gains. Capital losses may be fully deducted against capital gains and also may offset up to $3,000 of ordinary income ($1,500 for married filing separately). In general, when you take losses, you must first match your long-term losses against your long-term gains, and short-term losses against short-term gains. If there are any remaining losses, you may use them to offset any remaining long-term or short-term gains, or up to $3,000 (or $1,500) of ordinary income. When and whether to recognize such losses should be analyzed in light of the possible future changes in the capital gains rates applicable to your specific investments.
Dividends: Qualifying dividends received in 2016 are subject to rates similar to the capital gains rates. Therefore, qualifying dividends are taxed at a maximum rate of 20% (23.8% if subject to the net investment tax). Qualifying dividends include dividends received from domestic and certain foreign corporations. Nonqualifying dividends are subject to ordinary income rates (up to 43.4% (39.6% income tax rate and 3.8% net investment income tax rate)).
Exclusion of Gain Attributable to Certain Small Business Stock: 100% of the gain on the sale of “small business stock” under §1202 that is acquired after September 27, 2010, is excluded from income. The stock must be held for more than five years to qualify. If you acquired such stock on or before September 27, 2010, other exclusion percentages apply. If you are in this situation, we can discuss the details.
Installment Sales: Generally, a sale occurs when you transfer property. If a gain will be realized on the sale, income recognition will normally be deferred under the installment method until payments are received, so long as one payment is received in the year after the sale. So if you are expecting to sell property at year-end, and it makes economic sense, consider selling the property using the installment method to defer payments (and tax) until next year or later.
Selling Your (Underwater) Home: Qualified principal residence mortgage debt discharged by your lender in 2016 is excludible from gross income. Unless extended by Congress, this exclusion does not apply after December 31, 2016.
Social Security: Depending on the recipient's modified AGI and the amount of Social Security benefits, a percentage — up to 85% — of Social Security benefits may be taxed. To reduce that percentage, it may be beneficial to defer receipt of other retirement income. One way to do so is to elect to receive a lump-sum distribution from a retirement plan and to rollover that distribution into an IRA. Alternatively, it may be beneficial to accelerate income so as to reduce the percentage of your Social Security taxed in 2017 and later years.
Other Tax Planning Opportunities: We also can discuss the potential benefits to you or your family members of other planning options available for 2016, including §529 qualified tuition programs.
Health Care Planning
Individual Mandate: Under the 2010 health care reform law, sometimes called Obamacare, there is an individual mandate requiring individuals and their dependents to have health insurance that is minimum essential coverage or pay a penalty unless they are exempt from the requirement. Many people already have qualifying coverage, which can be obtained through the individual market, an employer-provided plan or coverage, a government program such as Medicare or Medicaid, or an Exchange. For lower-income individuals who obtain health insurance in the individual market through an Exchange, a premium tax credit and cost-sharing reductions may be available to offset the costs.
Health Care Savings Accounts: For 2016, cafeteria plans can provide that employees may elect no more than $2,550 in salary reduction contributions to a health FSA.
Self-Employed Health Insurance Premiums: Self-employed individuals are allowed to claim 100% of the amount paid during the taxable year for insurance that constitutes medical care for themselves, their spouses and dependents as an above-the-line deduction, without regard to the general 10% of AGI floor.
Health Savings Accounts: A health savings account (HSA) is a trust or custodial account exclusively created for the benefit of the account holder and his or her spouse and dependents, and is subject to rules similar to those applicable to individual retirement arrangements (IRAs). Contributions to an HSA are deductible, within limits. For 2016, the annual limitation on deductions for an individual with self-only coverage under a high deductible health plan is $3,350; for an individual with family coverage under a high deductible health plan is $6,750. For 2016, a “high deductible health plan” is a health plan with an annual deductible that is not less than $1,300 for self-only coverage or $2,600 for family coverage, and the annual out-of-pocket expenses (deductibles, co-payments, and other amounts, but not premiums) do not exceed $6,550 for self-only coverage or $13,100 for family coverage.
Alternative Minimum Tax
For 2016, the alternative minimum tax exemption amounts are: (1) $83,800 for married individuals filing jointly and for surviving spouses; (2) $53,900 for unmarried individuals other than surviving spouses; and (3) $41,900 for married individuals filing a separate return. Also, for 2016, nonrefundable personal credits can offset an individual's regular and alternative minimum tax, and capital gains will be taxed at lower favorable rates for AMT. For 2016, the amount of AMTI above which the 28% rate applies is $93,150 for married taxpayers filing separate returns and $186,300 for married individuals filing joint returns, single taxpayers (other than surviving spouses), and estates and trusts.
If you have a stock holding due to the exercise of an incentive stock option during this year that is now below the value at the exercise date (underwater), consider selling the shares before the end of the year to avoid the AMT tax due on the original exercise of the option.
Some of the standard year-end planning ideas will not reduce tax liability if you are subject to the alternative minimum tax (AMT) because different rules apply. Because of the complexity of the AMT, it would be wise for us to analyze your AMT exposure.
FBAR: U.S. persons holding any financial interest in, or signature or other authority over, a foreign financial account exceeding $10,000 at any time in a calendar year must file a Report of Foreign Bank and Financial Accounts (FBAR) with the Treasury Department. The due date for 2016 is the same as the U.S. tax filing deadline of April 15, 2017 (unless extended by a weekend or holiday), with a maximum six-month extension to October 15.
Penalties: The tax code imposes a host of penalties for failure to file returns with the IRS, failure to furnish information returns, and failure to pay tax. Many penalties are subject to inflation adjustments.
If you have any questions, please do not hesitate to call. I would be happy to meet with you at your convenience to discuss the strategies outlined above. While we are getting very close to the end of the year, there is still time to implement these strategies to minimize your 2016 tax liability.
Kalender & Rodenbeck CPA's LLC
As the end of the year approaches, it is a good time to think of planning moves that will help lower your tax bill for this year and possibly the next. Factors that compound the planning challenge this year include turbulence in the stock market, overall economic uncertainty, and Congress's all too familiar failure to act on a number of important tax breaks that will expire at the end of 2016.
Some of these expiring tax breaks will likely be extended, but perhaps not all, and as in the past, Congress may not decide the fate of these tax breaks until the very end of 2016 (or later). For individuals, these breaks include: the exclusion for discharge of indebtedness on a principal residence, the treatment of mortgage insurance premiums as deductible qualified residence interest, the 7.5% of adjusted gross income floor beneath medical expense deductions for taxpayers age 65 or older, and the deduction for qualified tuition and related expenses. There is also a host of expiring energy provisions, including: the nonbusiness energy property credit, the residential energy property credit, the qualified fuel cell motor vehicle credit, the alternative fuel vehicle refueling property credit, the credit for 2-wheeled plug-in electric vehicles, the new energy efficient homes credit, and the hybrid solar lighting system property credit. For a full listing of these provisions, see ¶601 .
Higher-income earners have unique concerns to address when mapping out year-end plans. They must be wary of the 3.8% surtax on certain unearned income and the additional 0.9% Medicare (hospital insurance, or HI) tax.
The surtax is 3.8% of the lesser of: (1) net investment income (NII), or (2) the excess of modified adjusted gross income (MAGI) over an unindexed threshold amount ($250,000 for joint filers or surviving spouses, $125,000 for a married individual filing a separate return, and $200,000 in any other case). As year-end nears, a taxpayer's approach to minimizing or eliminating the 3.8% surtax will depend on his estimated MAGI and NII for the year. Some taxpayers should consider ways to minimize (e.g., through deferral) additional NII for the balance of the year, others should try to see if they can reduce MAGI other than NII, and other individuals will need to consider ways to minimize both NII and other types of MAGI.
The 0.9% additional Medicare tax also may require year-end actions. It applies to individuals for whom the sum of their wages received with respect to employment and their self-employment income is in excess of an unindexed threshold amount ($250,000 for joint filers, $125,000 for married couples filing separately, and $200,000 in any other case). Employers must withhold the additional Medicare tax from wages in excess of $200,000 regardless of filing status or other income. Self-employed persons must take it into account in figuring estimated tax. There could be situations where an employee may need to have more withheld toward the end of the year to cover the tax. For example, if an individual earns $200,000 from one employer during the first half of the year and a like amount from another employer during the balance of the year, he would owe the additional Medicare tax, but there would be no withholding by either employer for the additional Medicare tax since wages from each employer don't exceed $200,000. Also, in determining whether they may need to make adjustments to avoid a penalty for underpayment of estimated tax, individuals also should be mindful that the additional Medicare tax may be overwithheld. This could occur, for example, where only one of two married spouses works and reaches the threshold for the employer to withhold, but the couple's combined income won't be high enough to actually cause the tax to be owed.
We have compiled a checklist of additional actions based on current tax rules that may help you save tax dollars if you act before year-end. Not all actions will apply in your particular situation, but you (or a family member) will likely benefit from many of them. We can narrow down the specific actions that you can take once we meet with you to tailor a particular plan. In the meantime, please review the following list and contact us at your earliest convenience so that we can advise you on which tax-saving moves to make:
Year-End Tax Planning Moves for Individuals
• Realize losses on stock while substantially preserving your investment position. There are several ways this can be done. For example, you can sell the original holding, then buy back the same securities at least 31 days later. It may be advisable for us to meet to discuss year-end trades you should consider making.
• Postpone income until 2017 and accelerate deductions into 2016 to lower your 2016 tax bill. This strategy may enable you to claim larger deductions, credits, and other tax breaks for 2016 that are phased out over varying levels of adjusted gross income (AGI). These include child tax credits, higher education tax credits, and deductions for student loan interest. Postponing income also is desirable for those taxpayers who anticipate being in a lower tax bracket next year due to changed financial circumstances. Note, however, that in some cases, it may pay to actually accelerate income into 2016. For example, this may be the case where a person's marginal tax rate is much lower this year than it will be next year or where lower income in 2017 will result in a higher tax credit for an individual who plans to purchase health insurance on a health exchange and is eligible for a premium assistance credit.
• If you believe a Roth IRA is better than a traditional IRA, consider converting traditional-IRA money invested in beaten-down stocks (or mutual funds) into a Roth IRA if eligible to do so. Keep in mind, however, that such a conversion will increase your AGI for 2016.
• If you converted assets in a traditional IRA to a Roth IRA earlier in the year and the assets in the Roth IRA account declined in value, you could wind up paying a higher tax than is necessary if you leave things as is. You can back out of the transaction by recharacterizing the conversion-that is, by transferring the converted amount (plus earnings, or minus losses) from the Roth IRA back to a traditional IRA via a trustee-to-trustee transfer. You can later reconvert to a Roth IRA.
• It may be advantageous to try to arrange with your employer to defer, until early 2017, a bonus that may be coming your way.
• Consider using a credit card to pay deductible expenses before the end of the year. Doing so will increase your 2016 deductions even if you don't pay your credit card bill until after the end of the year.
• If you expect to owe state and local income taxes when you file your return next year, consider asking your employer to increase withholding of state and local taxes (or pay estimated tax payments of state and local taxes) before year-end to pull the deduction of those taxes into 2016 if you won't be subject to alternative minimum tax (AMT) in 2016.
• Take an eligible rollover distribution from a qualified retirement plan before the end of 2016 if you are facing a penalty for underpayment of estimated tax and having your employer increase your withholding is unavailable or won't sufficiently address the problem. Income tax will be withheld from the distribution and will be applied toward the taxes owed for 2016. You can then timely roll over the gross amount of the distribution, i.e., the net amount you received plus the amount of withheld tax, to a traditional IRA. No part of the distribution will be includible in income for 2016, but the withheld tax will be applied pro rata over the full 2016 tax year to reduce previous underpayments of estimated tax.
• Estimate the effect of any year-end planning moves on the AMT for 2016, keeping in mind that many tax breaks allowed for purposes of calculating regular taxes are disallowed for AMT purposes. These include the deduction for state property taxes on your residence, state income taxes, miscellaneous itemized deductions, and personal exemption deductions. Other deductions, such as for medical expenses of a taxpayer who is at least age 65 or whose spouse is at least 65 as of the close of the tax year, are calculated in a more restrictive way for AMT purposes than for regular tax purposes. If you are subject to the AMT for 2016, or suspect you might be, these types of deductions should not be accelerated.
• You may be able to save taxes this year and next by applying a bunching strategy to "miscellaneous" itemized deductions, medical expenses and other itemized deductions.
• For 2016, the "floor" beneath medical expense deductions for those age 65 or older is 7.5% of adjusted gross income (AGI). Unless Congress changes the rules, this floor will rise to 10% of AGI next year. Taxpayers age 65 or older who can claim itemized deductions this year, but won't be able to next year because of the higher floor, should consider accelerating discretionary or elective medical procedures or expenses (e.g., dental implants or expensive eyewear).
• You may want to pay contested taxes to be able to deduct them this year while continuing to contest them next year.
• You may want to settle an insurance or damage claim in order to maximize your casualty loss deduction this year.
• Take required minimum distributions (RMDs) from your IRA or 401(k) plan (or other employer-sponsored retirement plan). RMDs from IRAs must begin by April 1 of the year following the year you reach age 70-½. That start date also applies to company plans, but non-5% company owners who continue working may defer RMDs until April 1 following the year they retire. Failure to take a required withdrawal can result in a penalty of 50% of the amount of the RMD not withdrawn. Although RMDs must begin no later than April 1 following the year in which the IRA owner attains age 70-½, the first distribution calendar year is the year in which the IRA owner attains age 70-½. Thus, if you turn age 70-½ in 2016, you can delay the first required distribution to 2017, but if you do, you will have to take a double distribution in 2017-the amount required for 2016 plus the amount required for 2017. Think twice before delaying 2016 distributions to 2017, as bunching income into 2017 might push you into a higher tax bracket or have a detrimental impact on various income tax deductions that are reduced at higher income levels. However, it could be beneficial to take both distributions in 2017 if you will be in a substantially lower bracket that year.
• Increase the amount you set aside for next year in your employer's health flexible spending account (FSA) if you set aside too little for this year.
• If you become eligible in December of 2016 to make health savings account (HSA) contributions, you can make a full year's worth of deductible HSA contributions for 2016.
• If you are thinking of installing energy saving improvements to your home, such as certain high-efficiency insulation materials, do so before the close of 2016. You may qualify for a "nonbusiness energy property credit" that won't be available after this year, unless Congress reinstates it.
• Make gifts sheltered by the annual gift tax exclusion before the end of the year and thereby save gift and estate taxes. The exclusion applies to gifts of up to $14,000 made in 2016 and 2017 to each of an unlimited number of individuals. You can't carry over unused exclusions from one year to the next. The transfers also may save family income taxes where income-earning property is given to family members in lower income tax brackets who are not subject to the kiddie tax.
Year-End Tax-Planning Moves for Businesses & Business Owners
Businesses should consider making expenditures that qualify for the business property expensing option. For tax years beginning in 2016, the expensing limit is $500,000 and the investment ceiling limit is $2,010,000. Expensing is generally available for most depreciable property (other than buildings), off-the-shelf computer software, and qualified real property-qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property. The generous dollar ceilings that apply this year mean that many small and medium sized businesses that make timely purchases will be able to currently deduct most if not all their outlays for machinery and equipment. What's more, the expensing deduction is not prorated for the time that the asset is in service during the year. This opens up significant year-end planning opportunities.
Businesses also should consider making expenditures that qualify for 50% bonus first year depreciation if bought and placed in service this year. The bonus depreciation deduction is permitted without any proration based on the length of time that an asset is in service during the tax year. As a result, the 50% first-year bonus writeoff is available even if qualifying assets are in service for only a few days in 2016.
• Businesses may be able to take advantage of the "de minimis safe harbor election" (also known as the book-tax conformity election) to expense the costs of lower-cost assets and materials and supplies, assuming the costs don't have to be capitalized under the Code Sec. 263A uniform capitalization (UNICAP) rules. To qualify for the election, the cost of a unit of property can't exceed $5,000 if the taxpayer has an applicable financial statement (AFS; e.g., a certified audited financial statement along with an independent CPA's report). If there's no AFS, the cost of a unit of property can't exceed $2,500. Where the UNICAP rules aren't an issue, purchase such qualifying items before the end of 2016.
• A corporation should consider accelerating income from 2017 to 2016 if it will be in a higher bracket next year. Conversely, it should consider deferring income until 2017 if it will be in a higher bracket this year.
• A corporation should consider deferring income until next year if doing so will preserve the corporation's qualification for the small corporation AMT exemption for 2016. Note that there is never a reason to accelerate income for purposes of the small corporation AMT exemption because if a corporation doesn't qualify for the exemption for any given tax year, it will not qualify for the exemption for any later tax year.
• A corporation (other than a "large" corporation) that anticipates a small net operating loss (NOL) for 2016 (and substantial net income in 2017) may find it worthwhile to accelerate just enough of its 2017 income (or to defer just enough of its 2016 deductions) to create a small amount of net income for 2016. This will permit the corporation to base its 2017 estimated tax installments on the relatively small amount of income shown on its 2016 return, rather than having to pay estimated taxes based on 100% of its much larger 2017 taxable income.
• If your business qualifies for the domestic production activities deduction (DPAD) for its 2016 tax year, consider whether the 50%-of-W-2 wages limitation on that deduction applies. If it does, consider ways to increase 2016 W-2 income, e.g., by bonuses to owner-shareholders whose compensation is allocable to domestic production gross receipts. Note that the limitation applies to amounts paid with respect to employment in calendar year 2016, even if the business has a fiscal year.
• To reduce 2016 taxable income, consider deferring a debt-cancellation event until 2017.
• To reduce 2016 taxable income, consider disposing of a passive activity in 2016 if doing so will allow you to deduct suspended passive activity losses.
• If you own an interest in a partnership or S corporation, consider whether you need to increase your basis in the entity so you can deduct a loss from it for this year.
These are just some of the year-end steps that can be taken to save taxes. Again, by contacting us, we can tailor a particular plan that will work best for you.
Very truly yours,
Kalendar & Rodenbeck CPA's LLC
As year-end approaches, you should consider the following moves to make the best tax use of paper losses and actual losses from your stock market investments.
Sell at a loss to offset earlier gains. If you have realized gains earlier in the year from sales of stock held for more than one year (long-term capital gains) or from sales of stock held for one year or less (short-term capital gains), take a close look at your portfolio with a view to selling some of the losers-those shares that now show a paper loss. The best tax strategy is to sell enough of the losers to generate losses to offset your earlier gains plus an additional $3,000 loss. Selling to produce this amount of loss is a good idea from the tax viewpoint because a $3,000 capital loss (but no more) can offset a like amount of ordinary income each year.
For example, let's suppose you have $10,000 of capital gain from the sale of stocks earlier this year. You also have several losing positions, including shares in ABC Corp. The ABC shares currently show a loss of $15,000. Strictly from the tax viewpoint, you should consider selling enough of your ABC shares to recognize a $13,000 loss. Your capital gains will be offset entirely, and you will have a $3,000 loss to offset against a like amount of ordinary income.
Suppose that you believe that the shares showing a paper loss (in our example, the ABC shares) still have the potential to turn around and eventually generate a profit. You can sell and then repurchase the shares without forfeiting the loss deduction only if you avoid the wash-sale rules. This means that you must buy the new shares outside of the period that begins 30 days before and ends 30 days after the sale of the loss stock. However, note that if you expect the price of the shares showing a paper loss to rise quickly, your tax savings from taking the loss may not be worth the potential investment gain you may lose by waiting more than 30 days to repurchase the shares.
Use earlier-in-the-year losses to offset gains you would benefit from taking. If you have capital losses on sales earlier in the year, consider whether you should take capital gains on some stocks that you still hold. For example, if you have appreciated stocks that you would like to sell, but don't want to sell if it will cause you to have taxable gain this year, consider selling just enough shares to offset your earlier-in-the-year capital losses (except for $3,000 of those which can be used to offset ordinary income). You should consider selling appreciated stocks now if you believe those stocks have reached (or are close to) the peak price and you also believe that you can invest the proceeds from the sale in other property that will give you a better rate of return in the future.
For example, suppose you have $20,000 of long-term capital losses from last year's stock transactions, and $4,000 of short-term capital gains. If you don't have other transactions involving securities or other capital assets during last year, you'll wind up the year with a $16,000 long-term capital loss, of which only $3,000 can be used to shelter ordinary income. The $13,000 balance of the loss could be used to offset gain on appreciated stock that you wish to sell but which you would not sell now if you had to pay tax on the gain recognized on the sale.
If this strategy applies to you, and your holdings showing a paper gain consist of stocks you haven't held for more than one year, as well as stocks you have held for more than one year, you should consider selling those stocks on which you will have short-term gain first, and then stocks that would yield long-term gain. This way, you'll be in a better position to wind up with gain taxed at favorable rates when you sell other stocks with paper gains. To the extent possible, you should also try to use long-term capital losses to offset short-term capital gains. This can be done, however, only if the total of your long-term capital losses is more than your long-term capital gains. Deferring long-term capital gains until next year is one way of achieving this goal.
Since individual taxpayers may carry over capital losses indefinitely, there is no reason to sell appreciated stocks just to have offsetting gains. If you don't have a better investment for the proceeds of a sale of these stocks, don't sell them. You can carry over your capital losses to next year when you may have a better opportunity to make use of those losses. You can even offset another $3,000 of the carried over losses against ordinary income next year (and in succeeding years if the full amount of the capital loss carryover is not used next year).
These are just a few of the year-end strategies that can make a big dollar difference to you and your family. To discuss these and other strategies that should be put in place before year end, please call at your convenience.
Very truly yours,
Kalendar & Rodenbeck CPA's LLC
Without provisions in the Bipartisan Budget Act of 2015, nearly one-third of Part B participants would have been forced to bear the cost of premium increases that would typically be shared by all.
By James Sullivan, CPA/PFS
Approximately 30% of Medicare Part B beneficiaries will see their premiums increase next year—but those hikes will be much smaller than anticipated thanks to a new law signed on Nov. 2. The even better news is that 70% of beneficiaries will not see any increases at all.
Without provisions in the Bipartisan Budget Act of 2015, P.L. 114-74, nearly one-third of Part B participants would have been forced to bear the cost of premium increases that would typically be shared by all. Financial planners have closely watched the complicated situation, which arose due to the fact that there will be no Social Security cost-of-living adjustment (COLA) in 2016 because of low inflation. Let’s take a closer look at why this was happening, why the affected recipients ended up having to pay less, and just how much it will actually cost them.
The federal government pays 75% of Part B costs, and monthly premiums paid by beneficiaries fund the remaining cost. In most years, the annual cost increase is borne by all Medicare beneficiaries. However, under a “hold harmless” provision in the law, Social Security benefits cannot be reduced below the prior-year benefits due to increasing Medicare premium costs. Because there will be no Social Security COLA for 2016, any increase in the Medicare premium (usually deducted from the beneficiary’s Social Security check) would result in a net reduction in the beneficiary’s check—which would run afoul of the hold-harmless provision.
Why only about one-third of recipients would have had to pay all the increase
Since 25% of Part B costs must be paid through beneficiary premiums, the hikes were set to affect only those beneficiaries who do not benefit from the hold-harmless provision. This means the increase in Part B costs would have been spread among a much smaller group—about 30% of beneficiaries.
The beneficiaries not subject to the hold-harmless provisions include:
How the new law affects premiums
The new law provides for no increase for those who benefit from the hold-harmless provision. For those not held harmless, the 2016 Medicare Part B premiums will be:
*Means tested based on 2014 modified adjusted gross income, or MAGI. Premiums include a surcharge added to pay for the cost of the reduced premium rate in 2016.
The Part B annual deductible will apply to all beneficiaries. For 2016, it will increase to $166 from $147. (Click here for more on the financial machinations required to arrive at these rates.)
What financial planners should do
Personal financial planners should use the annual announcement regarding next year’s Part B premium as well as the annual Medicare enrollment period that runs from Oct. 15 through Dec. 7 to encourage clients to review their Medicare costs and planning opportunities. While there is nothing they can do to plan around the Part B premium, they can review other aspects of their coverage to determine if savings are available:
By Anne Tergesen
Congress recently put an end to a pair of Social Security-claiming strategies that couples have used to add tens of thousands of dollars to their lifetime retirement incomes. Now, spouses who want to maximize their benefits will need to become familiar with the next-best claiming strategies.
For spouses who both have significant earnings, it will generally make sense for the higher earner to delay collecting benefits and the lower earner to collect early. For other couples in which one person has earned a lot more than the other, the changes may lead higher earners to file for Social Security earlier than they might have otherwise.
The tactics being eliminated—known as file-and-suspend and a restricted application for spousal benefits—have made it possible for both members of a couple who are 66 or older to delay claiming Social Security based on their own earnings records in order to increase those payments, while at the same time, one spouse pockets a spousal benefit.
But starting in about six months, people who file for benefits and then suspend them will also suspend Social Security payments for spouses and dependents that would be based on the same work record. Those who file and suspend before May will be grandfathered, which means their spouses will still have the option to claim a spousal benefit based on a suspended benefit.
Meanwhile, workers who are younger than 62 at the end of this year will lose the right in the future to file a restricted application to claim only a spousal benefit and then switch to their own benefit later. Instead, when they apply for a retirement benefit, they will receive either their own earned benefit or a spousal benefit—whichever is higher.
Those who are 62 or older at year-end retain the ability to file a restricted application at their full retirement age, as long as their spouse has suspended or is taking benefits. (Couples already using these strategies will be allowed to continue doing so.)
For couples barred under the new rules from using either of these strategies, claiming decisions may become less complicated. But because claims will also be less lucrative, it’s more important than ever to use a coordinated strategy to squeeze the maximum from spouses’ combined benefits, says Michael Kitces, director of financial planning at Pinnacle Advisory Group Inc. in Columbia, Md. He recommends consulting with an adviser or using one of a growing number of websites that provide claiming advice.
Here are basic guidelines for two types of couples:
First, consider the options for a couple in which both spouses have work histories and the lower earner’s projected Social Security benefits are at least half that of the higher earner.
While there are some exceptions, in this scenario both spouses will generally collect Social Security retirement benefits based only on their own earnings. (A spousal benefit is typically a maximum of half of what a worker is entitled to at his or her full retirement age.)
While each spouse can start taking benefits any time between ages 62 and 70, it often pays for the higher earner to put off claiming as long as possible, preferably until age 70. Why? The longer you wait to claim, the higher your monthly payment.
Take for example a couple where the higher earner, the husband, is entitled to $1,800 a month at age 62. He would be eligible for $3,151 a month if he waits until age 70 to claim, according to Social Security Solutions, which sells Social Security claiming advice. Should he die first, his spouse would typically collect his benefit rather than her own, as it would be higher.
For a relatively high-earning couple who are the same age, one spouse has to live to 83 for the couple to come out ahead by delaying the higher earner’s benefits until 70, says Baylor University professor William Reichenstein, a principal at Social Security Solutions.
Because the probability of one member of a 65-year-old couple reaching 90 is about 60%, Mr. Kitces says using such a strategy “is the odds-on bet.”
In contrast, it generally makes sense for the lower earner—the wife in this example—to claim her benefit relatively early, at age 62 or 63.
Why? The odds are less than 50% that both spouses will live beyond 81, Mr. Kitces says. Given that the low earner’s Social Security retirement benefit will stop when the first spouse dies, those odds argue in favor of the low earner claiming early, he adds.
In this case, if the wife died first, the husband would simply continue to collect his own benefit. If the husband died first, the wife would get a survivor benefit based on his earnings rather than her earned benefit.
Health and family history should also be a consideration.
“With a married couple, the decision to delay benefits must be evaluated based on the life expectancies of both members of the couple,” says Mr. Kitces. “If both are in poor health, it won’t pay to delay much. And if both are likely to live well beyond 90, there can still be a value for both to delay to 70. But for most with average life expectancies, the most common strategy will be to delay the higher-earning spouse as long as possible but start the lower earning spouse’s benefits as early as possible.”
Couples With One Primary Earner
The math is different for couples in which only one spouse qualifies for an earned Social Security retirement benefit or where one spouse’s benefit is more than double the other’s.
For them, it is often best for the high earner to wait to claim—but only until the low earner reaches full retirement age, which is 66 for those born between 1943 and 1954.
To see why, consider Bob and Sally, who are both younger than 62 and whose respective monthly benefits at full retirement age are $2,685 and $500. Once Bob claims his benefit, Sally will become eligible for an $842 spousal supplement, which will bump her $500 benefit to $1,342, or half of Bob’s.
For Sally to get the most from Social Security, she will want to start her spousal supplement at 66. Why? Spousal benefits stop growing at 66, so Sally won’t receive the delayed retirement credits that increase a worker’s benefit by 6% to 8% for each year he or she puts off claiming between 66 and 70. (But if she starts claiming before 66, her benefits will be reduced.)
Under the new rules, Sally can’t receive her spousal supplement unless Bob claims his benefit. But if Bob takes his benefit before 70, he won’t receive the $3,544 maximum he’s eligible for at 70, which would force the couple to accept a lower survivor benefit.
What should they do? If Bob is four or more years older than Sally, the decision is easy, says Joe Elsasser, founder of Social Security Timing, a software program advisers use to identify optimal claiming strategies. Bob should file at 70 and get the maximum he is entitled to. And Sally should claim her own benefit at 62—she’ll actually receive less than the $500 because she’s claiming early—and pick up her spousal supplement when Bob starts his benefits at 70.
If Bob is less than four years older than Sally or is younger, the decision on when Bob should start his benefit becomes trickier. The couple will have to decide whether it is worth forfeiting some of Sally’s $842 spousal supplement—which sums to $10,104 a year—to secure a higher benefit for Bob.
“If both live long enough it may still pay to delay,” says Prof. Reichenstein.
Still, he expects many couples to decide against having the high earner delay all the way to age 70. With the changes in the rules, “the high earner is more likely to claim benefits earlier than he or she would have so that the low earner can add spousal benefits sooner,” Prof. Reichenstein says.
"We have long had death and taxes as the two standards of inevitability. But there are those who believe that death is the preferable of the two. "At least," as one man said, "there's one advantage about death; it doesn't get worse ever time Congress meets."
~ Erwin. N. Griswold
Another difference between death and taxes is that death is frequently painless.
The Pricier the House, the Bigger the Financial Drain
By Jonathan Clements
Nov. 22, 2014 8:14 p.m. ET
Once you’ve paid for your house, how much will it cost you?
This is a crucial issue for anyone looking ahead to retirement. The more expensive your home, the more of a drain it’ll likely be in terms of property taxes, maintenance, homeowners insurance and more.
Suppose you own a home that, in addition to any mortgage payment, costs $1,000 a month. You then get a fat pay raise, prompting you to trade up to a larger house, which has double the monthly expenses.
Result: If you stay in the larger home during retirement, you’ll need to come up with $2,000 a month, equal to $24,000 a year. Based on a 4% annual portfolio withdrawal rate, that would mean $600,000 in retirement savings just to pay your housing costs, versus $300,000 for the smaller home.
“I’ve always been an advocate of modest homes,” says Charles Farrell, chief executive of Denver’s Northstar Investment Advisors and author of “Your Money Ratios.” A large house “means higher costs in retirement and it makes it more difficult to save while you’re working.”
Whatever price you pay for a house, it’ll often end up costing you at least 2½ times as much over the long term, Mr. Farrell reckons. Say you buy a $500,000 home, put down $100,000 and borrow the other $400,000.
You’ll pay back the $400,000 with that portion of every mortgage payment that goes toward principal. In addition, you might cough up another $250,000 or so in interest, even after figuring in the tax deduction. This assumes a 4.5% 30-year fixed-rate mortgage and a 25% federal income-tax bracket. Add that to the purchase price and you’re up to $750,000.
On top of that, Mr. Farrell figures the house might cost $20,000 to $25,000 a year, between property taxes, insurance, maintenance and occasional improvements. To generate that income in retirement, you might need $500,000 in savings, and probably more once you figure in the taxes on any investment gains. That brings the total tab to $1.25 million, or 2½ times the purchase price.
Mr. Farrell’s estimate for housing costs might strike some readers as high. It’s easy enough to get a handle on property taxes and insurance. Annual property taxes typically run 1% to 2% of a home’s value, while insurance might equal 0.5%.
It’s harder to get a grip on maintenance and occasional improvements, in part because homeowners may go a few years without any major expenses, but then fork over hefty sums for a new roof or a kitchen remodeling. These projects, which are often necessary just to maintain a property’s value, are easy to dismiss as one-time expenses—and yet they seem to roll around with fair frequency.
Whether you think Mr. Farrell’s numbers are too low or too high, he makes an important point: High housing costs can make it tough to retire, because they crimp our ability to save while we’re working and increase the nest egg we’ll need to retire in comfort.
Indeed, Mr. Farrell advises folks to buy homes that cost no more than 2 to 2½ times their gross income. That’s doable in many parts of the country, but it’s almost impossible if you live in a major city on the East or West Coast.
“The coasts are tough,” Mr. Farrell concedes. “I know people aren’t happy with those figures, but they’re prudent.”
This issue of housing costs brings together two themes I often harp on. First, you’ll have more financial breathing room—and less financial stress—if you hold down your fixed living costs, including mortgage or rent, car payments, property taxes, insurance premiums and utilities. One rule of thumb: Try to keep these costs to 50% or less of your pretax income. That way, if you’re laid off, you know you can get by on half of your old salary.
Second, temporarily cutting back spending is a key financial tool, especially for retirees faced with rough financial markets. The lower your fixed living costs, the more flexibility you’ll have.
Still tempted to buy the big home? Keep Mr. Farrell’s math in mind.
“If you’re going to buy an $800,000 house, the real cost is close to $2 million,” he says. “You have to ask yourself whether you can afford it. It’s a tough one to fight against, because people still have this perception that a home is a good investment. But most of the time, it’s a money pit.”
Start With Your Employer’s Plan, Then Consider Low-Cost ETFs and Index Funds
Nov. 8, 2014 8:11 p.m. ET
Sellers of lottery tickets suggest all you need is a dollar and a dream. Forget that nonsense: If you want a decent shot at making money, you’ll need at least $50—and instead of lottery tickets, try a few carefully chosen mutual funds.
Looking to get started as an investor? Here are my top five suggestions for those without much money:
Your employer’s plan: This is a no-brainer, and not just because of the tax advantages and possible matching employer contribution. Many 401(k) and 403(b) plans, especially those offered by large employers, include a select list of low-cost mutual funds. That makes it relatively easy for employees to build sensible portfolios.
On top of that, there’s no required minimum investment. Got younger colleagues or children in their 20s? Prod them to sign up for their employer’s plan. When I was at Forbes magazine in the late 1980s with a miserably low salary and a young family to support, I initially didn’t contribute to the retirement plan. To my surprise, I got a call from the company’s treasurer, who cajoled me into signing up. He said I’d quickly get used to living without the money—and he was right.
Ignore the naysayers. I think the funds are a great choice for most investors, who would struggle to put together anything better on their own or working with a financial adviser.
Vanguard Group’s target-date funds charge average annual expenses of just 0.17%, or 17 cents a year for every $100 invested, and have a $1,000 minimum. Each fund owns a mix of market-tracking stock- and bond-index funds. That mix becomes more conservative as a fund approaches its target date.
Schwab’s index funds: Charles Schwab SCHW -0.18% Billion Dividend Yield 0.85offers five conventional stock-index mutual funds and three bond-index funds, all with $100 minimums. Its U.S. total stock-market fund charges a slim 0.09%, its international-index fund levies 0.19% and its total bond-market fund costs 0.29%. All three funds would make good core portfolio holdings.
Exchange-traded funds: Instead of buying index-mutual funds, you could open a brokerage account and purchase exchange-traded index funds. Both types of funds seek to track the performance of an underlying market index. ETFs, however, are listed on the stock market and can be traded anytime the market is open, while mutual funds can be
position and TradeKing have no required minimum to open a brokerage account, whileE*Trade ETFC -1.06% E*TRADE Financial Corp. Your Value Your Change Short position will let you start an account with $500. Schwab requires $1,000, but it will waive that minimum if you add $100 a month to your account.
Some brokerage firms let you trade certain ETFs without paying a commission. That’s attractive. But before buying, check that a fund’s annual expenses are low, preferably below 0.2%. As a rule, ETFs should have lower fees than comparable mutual funds, because they don’t incur the cost of handling shareholder accounts; that’s done by brokerage firms. You might start with three ETFs: a broadly diversified U.S. stock fund, U.S. bond fund and foreign-stock fund.
Actively managed funds: Regular readers know my fondness for index funds. What if you prefer actively managed funds?
Artisan Funds, Buffalo Funds and Scout Investments will waive their regular minimums if you agree to invest $50 or $100 automatically every month. Alternatively, for a $500 initial investment, you can buy into the Homestead Funds and some of the Nicholas Company funds.
But if you want active management and you can get together $1,000, I would consider one of T. Rowe Price Group TROW -0.17% T. Rowe Price Group Inc. U.S.: Nasdaq$83.14 -0.14-0.17 That $1,000 minimum applies if you buy the funds in an individual retirement account. I’m not predicting the T. Rowe funds will perform better than other funds mentioned here. But I like the broad diversification they offer.
A final point: An account with $100 or $1,000 won’t do you much good. Want to amass decent money? In your initial years as an investor, the key driver of your account’s growth won’t be the investment returns you earn. Rather, what matters is the dollars you sock away, so be sure to save as much as you can each month.
An onslaught of retiring baby boomers; the uncertain duration of Social Security funding; difficulty with workplace retirement accounts like 401(k)s – even if these factors were stronger than they are now, you’d still have a heavy burden in managing your finances during retirement, says financial planner Carl Edwards.
“Financial planning for retirement has always been a daunting prospect; the current landscape simply makes your preparation that much more crucial in using your assets well,” says Edwards, a highly credentialed consultant and owner of C.E. Wealth Group.
“Many advisors and clients rely too much on single product lines. This misuse often gives products and the financial industry in general a bad name. Advisors who are restricted in the types of financial products they can offer or understand may not provide the best advice. Independent and credentialed planners, on the other hand, don’t have their hands tied in what they can offer clients and may provide better advice.” Edwards reviews seven essential points that everyone should know regarding retirement planning.
1. Avoid trying to time the market. Markets often move in cycles and some investors believe that they can boost their investment returns by buying at the bottom and selling at the top. The problem is that investors are terrible at correctly predicting market movements and multiple studies have shown that market timers usually end up with significantly smaller retirement savings than buy-and-hold investors. While it can be stressful to see your portfolio plummet during a market correction, it’s important to stay calm and focus on your long-term strategy.
2. Use risk-appropriate financial vehicles. Retiring can be a risky business. The days of relying on employer-provided pension plans are largely over and retirees now have to deal with risks including investment, inflation, healthcare, longevity and others. Though the total elimination of risk isn’t possible, we can manage many of them through competent retirement planning and a clear understanding of factors like your goals, time horizon and financial circumstances.
3. Invest in the most tax-efficient manner. Taxes can take a big bite out of investment returns, which is why we stress tax-efficient planning with our clients. While taxes are just one piece of the overall financial puzzle, it’s important to structure your investments so that you are able to keep what you earn.
4. Complete a cash flow analysis. Retirement will involve major changes to your finances. Sources and timing of income will change and financial priorities may shift as you start generating income from retirement savings. A cash flow analysis will identify spending patterns and help ensure that you have enough income to support your retirement lifestyle.
5. Guarantee your required income. For many retirees, having income that is not subject to market fluctuations is an important part of their retirement plan. Many will have at least some level of guaranteed income from Social Security or defined benefit pension plans. However, if you are worried that your expenses exceed your guaranteed income, a financial advisor can help you explore options for additional streams of income for life. Guarantees are subject to the paying ability of the income provider.
6. Utilize longevity planning. Today’s retirees are living longer than ever and many worry about outliving their assets. Longevity planning is about preparing for a happy, comfortable and independent retirement and can help ensure that your wealth lasts as long as you need it to.
7. Consider the effects of inflation. Inflation is one of the biggest issues facing retirees because they are disproportionately affected by rising prices. Escalating food, fuel and medical costs can devastate a retirement portfolio unless these costs have been factored into your planning. Positioning your retirement portfolio to fight inflation is critical to ensuring adequate income in retirement.
Planning ahead for retirement will help ensure you can live comfortably long after your working days are over.