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Social Security


Coming ‘Of Age’ – ‘Retirement Age’ That Is…As more and more of our ‘baby boomers’ come of age and near the time for applying for social security benefits, I thought it might be appropriate to review a little bit about our social security benefit program as it applies to everyone.

It is extremely important to understand what our social security options are before we make a potentially irrevocable decision about taking and receiving our benefits as the dollar amounts received over our lifetimes could be meaningfully more!

Taxes – Funding Benefit and Receiving Benefit
Social security benefits are funded by contributions made through payroll taxes that are half paid by the employer and half paid by the employee with self-employeds effectively paying both halves. When we receive social security benefits they are income tax free unless you ‘make too much money’.

So managing income recognition and managing the character or type of income (cash flow) received when we are drawing social security benefits can be extremely important in maximizing what we keep of this otherwise income tax free benefit!

Social Security Benefits Started Before Full Retirement Age (FRA)
If you start your social security benefits before FRA you will receive a reduced benefit of about 75% at age 62, about 80% at age 63, about 87% at age 64 and age 65 about 93%. Another complication of drawing social security before the year in which you turn FRA is that if you keep working you will have to give back some of your social security earnings.

In 2013 that $1 of ‘giveback’ for every $2 of earned income starts when you make more than $15,120. In the year you reach FRA the ‘giveback’ becomes $1 for every $3 of earnings above $40,080 (2013 amount).

Social Security Benefits Started At Full Retirement Age (FRA)
Social security benefits are calculated based on a minimum of 40 credits (quarters of covered work) to be eligible for benefits. Depending on your birth date, your age of retirement, FRA, will vary between 65 and 67 years of age (if you were born after 1960).

The Social Security Benefits Administration has a calculator for you to run some what-ifs about choosing a retirement date. They also have other calculators that can run estimated benefits, offset effects (see discussion below), etc., etc. Besides the when to take retirement question, there are other strategies to consider in maximizing the social security benefits to be received.

One such strategy is called ‘file-and-suspend’ which may allow a qualifying recipient to suspend payments while the spouse files for spousal benefits.

Another strategy comes available to us when we have been married to another for at least 10 years. In those cases, you may qualify for benefits based upon the former spouses earnings. If you wait until your FRA, you can file on your former spouses earnings for a spousal benefit and delay taking your retirement until age 70. This strategy will not work if you apply for the spousal benefit before FRA!

Social Security Benefits Started At Age 70 (Post-FRA)
By waiting until age 70 to draw upon our social security benefits a person born after 1943 would have their FRA benefit increase 8% per year by waiting until age 70! Very compelling, indeed!

Social Security Benefits Post the Windsor Supreme Court Decision
As a result of the US Supreme Court decision on same sex marriages the Social Security administration is no longer prohibited from recognizing same-sex marriages for purposes of determining benefit claims filed after June 26, 2013. The decision and its social security benefits impact are being discussed by the Administration and exact details on same-sex marriage benefits will be forthcoming.

Medicare Starts At Age 65
Social security is one matter, Medicare is another! If you do not sign up for Medicare at age 65, your Medicare coverage may be delayed and cost more!

‘Other Pension’ Offsets to Social Security Benefits Received
Two issues that could impact your benefit received are the following.

  • Government Pension Offset. If you receive a pension from a federal, state or local government based on work where you did not pay Social Security taxes, your Social Security spouse’s or widow’s or widower’s benefits may be reduced.
  • Windfall Elimination Provision. The Windfall Elimination Provision primarily affects you if you earned a pension in any job where you did not pay Social Security taxes and you also worked in other jobs long enough to qualify for a Social Security retirement or disability benefit. A modified formula is used to calculate your benefit amount, resulting in a lower Social Security benefit than you otherwise would receive.

Survivors Benefits and Benefits for Children
Benefits can be made available to others based on our benefit should we die or become disabled. Two of those are survivor benefits (spouse) and benefits for children.

  • Survivor Benefits. Your widow or widower may be able to receive full benefits at full retirement age. Your widow or widower can receive benefits at any age if she or he takes care of your child who is receiving Social Security benefits and younger than age 16 or disabled.
  • Benefits for Children. Children of disabled, retired or deceased parents may be entitled to a benefit. Your child can get benefits if he or she is your biological child, adopted child or dependent stepchild. (In some cases, your child also could be eligible for benefits on his or her grandparents’ earnings.)

To get benefits, a child must have:

  • A parent(s) who is disabled or retired and entitled to Social Security benefits; or
  • A parent who died after having worked long enough in a job where he or she paid Social Security taxes.
  • The child also must be:
    • Unmarried;
    • Younger than age 18;
    • 18-19 years old and a full-time student (no higher than grade 12); or
    • 18 or older and disabled. (The disability must have started before age 22.)

Concluding Thoughts.
Social security benefits have been providing a ‘safety net’ to our citizens since the program came into existence.

Pre-retirement benefit programs like ‘Benefits for Children’ and ‘Surviving Spouses’ provide support to those qualifying families who have lost a breadwinner.

Retirement benefit program options are diverse and not readily understood by many. For some households social security retirement benefits comprise as much as 85% of household income so ensuring that one receives as much as is legally possible of the benefits that they have earned the right to, is so important! Consult with your advisor before you make any decisions. You may well be bound to them for your lifetime!

David Bergmann, CFP®, EA, CLU, ChFC
Managing Principal
The David Bergmann Group
Marina Del Ray, CA


3 Comments

Health Care Reform and You


Your Personal Declaration of IndependenceThe Patient Protection and Affordable Care Act, or PPACA, has many facets to it and its implementation will be done over several years. Provisions of the Act have ramifications for businesses and individuals so we will focus on the Health Care Reform Act and its impact on you as an individual. Since we are at about mid-year 2013 I wanted to focus on the Act for this year and next. To summarize 2013 and 2014, I offer the following …

In 2013,

  • Medicare Part A tax rate on wages goes up from 1.45% to 2.35% for certain individuals making more than $200,000 and couples making more than $250,000.
  • ‘Investment Income’ will have an additional 3.8% tax imposed if you make more than the $200,000 or $250,000.
  • Your employer must provide employees with info on employer plans, health exchanges and subsidies.
  • Your flexible spending account ‘set-aside’ will be limited to $2,500 per individual.
  • Medical expense deductions will not be deductible until they exceed 10% of AGI rather than the current 7.5%.

Beginning in 2014,

  • Waiting periods before you can enroll in an employer sponsored plan cannot be more than 90 days.
  • Insurance carriers will be required to cover everyone, even those with preexisting medical conditions.
  • If you are not covered through an employer health plan and do not purchase minimum essential health coverage on your own, you will have to pay a yearly fine of $95 per person ($695 in 2016) or 1% of taxable income (2.5% in 2016), whichever is greater. Individuals who do not have affordable minimum essential coverage from their employer will be eligible for tax credit subsidies for their health insurance purchase on a state exchange if their income is below 400 percent of federal poverty level – about $46,000. Minimum essential coverage includes Medicare, Medicaid, CHIP, TRICARE, individual insurance, grandfathered plans, and eligible employer-sponsored plans. Workers compensation and limited-scope dental or vision benefits are not considered minimum essential health coverage.
  • Group health plans, including grandfathered plans, may not impose cost-sharing amounts (i.e., copays or deductibles) that are more than the maximum allowed for high-deductible health plans (currently these limits are $5,000 for an individual and $10,000 for a family coverage). After 2014, these amounts will be adjusted for health insurance premium inflation. Group health plans, including grandfathered plans, may no longer include more than restricted annual or any lifetime dollar limits on essential health benefits for participants. Limits may exist in and after 2014 for non-essential benefits.
  • Each State must establish health insurance exchanges for individuals and small businesses defined, federally, as employers with less than 100 employees

What will the health insurance exchanges and pricing look like?

Obviously, each State is different. Some States run their own exchanges others have opted to let the Federal government run their State programs. There has been a lot said and predicted about policy pricing given the mandates of coverage and benefits provided for in the Act.

In California, we got our first look at our health care plans to be offered on California’s exchange. Our State will have 19 rating regions which will have 13 health carriers offering four plan types to Californians – Platinum, Gold, Silver and Bronze. California’s Silver Plan will have region costs that will vary for a 40-year-old from the low $200’s per month to the low $400’s per month depending on the region you live in. This is similar to our ‘zip-code-pricing’ currently used by companies in our State. The silver plan, which is expected to cover 70% of an individual’s health care expenses, has a $2,000 deductible, $45 copay for primary care visits, a $250 emergency room co-pay and a maximum annual out-of-pocket expense of $6,350.

According to Chad Terhune of the LA Times, for our 40-year old purchasing a Silver Plan and living in the Los Angeles County region they will be paying somewhere between $242 and $325 a month whereas a similarly designed plan today would cost $321 albeit with more comprehensive benefits. Statewide, considering all counties, the average premium in the State is $177. So the results thus far seem pleasing given the chatter about price increases.

In Ohio they have opted for the Federal government administered program to run the Ohio exchange. Fourteen carriers have submitted 214 different plans to the federal administered exchange. The price ranges for minimum essential health benefits through the federal administered exchanges range from $282 and $577. According to Ohio officials that will be an 88% increase in individual health policy costs for its citizens. . Other preliminary pricing for the 40-year old purchasing a Silver Plan has come in at a low of $205 in one region of Oregon to a high of $413 in a region in Vermont. The Congressional Budget Office had projected nationwide average monthly costs for the second lowest Silver Plan to average about $433. Results are still coming in so stay tuned.

One of the other provisions of PPACA is that health insurance companies must issue rebates to individuals and small businesses if the health insurance company does not spend at least 80% of their annual premiums on medical care. In recent filings with regulators, Blue Shield of California said it owed $24.5 million in rebates to thousands of small firms and similarly Blue Cross of California will be rebating $12 million.

Comments and Planning Implications.

So there is a lot to be played out yet with respect to the law and its implementation and pricing. Businesses have a lot of hoops to jump through with larger companies, publicly traded for example, probably less (a relative term, obviously) impacted than the smaller businesses especially those with more than 50 employees and less than 200. How the pricing and number of carriers willing to provide policies in your state will pan out between now and the end of the year is still a work in progress. For those who do not have insurance currently, or those who have policies that do not provide minimum essential coverage, consult with your advisor to see how the blend of tax subsidies, tax penalties and other issues of PPACA impact you, your family and your financial plans. To your healthy and successful financial future!

David Bergmann, CFP®, EA, CLU, ChFC
Managing Principal
The David Bergmann Group
Marina Del Ray, CA


20 Comments

FAMILY TAXATION


Skippin’ RocksMost of what we, as taxpayers, understand about taxation comes from our focus on taxes and how they affect us either individually or as a business. With the business owner, tax strategies will often be managed in aggregate between the business tax return and the owner’s personal return so as to optimize benefits and deductions and minimize taxes.

Rarely, however, do households look at aggregate family taxation to develop strategies for life’s expenditure requirements or desires – college education, first time homebuyer assistance, weddings, family member ‘support’, inter vivos wealth transfers, etc., etc., etc. The concept here is one of wealth and resources management through family income shifting and tax effect optimization. When, as practitioners, we do see family taxation considered in family financial activities there is usually a CERTIFIED FINANCIAL PLANNING™ professional involved.

So what are some of those family taxation considerations that the “pro’s” use for income shifting and tax effect optimization?

ASSETS YOU WON’T NEED AND ASSETS FOR SPECIFICALLY FUNDED PURPOSES

If you gift assets away, $14,000 per individual in 2013, they become the property of the transferee, your daughter for example, presuming you made what is called an irrevocable gift. The income on that asset will now become the income of, in this case, your daughter. If the asset gifted away is sold by your daughter, a gain or loss may be recognized by her based on your original purchase value and the tax rate upon the sale by the daughter will generally be based on the holding period (long term or short term) starting with you, not your daughter’s date of ownership. The strategy here for tax effect optimization is to have the income or gain from the asset taxed at the lowest rate of a family member.

If the gift was made to a minor, it would be made through a Uniform Transfer to Minors Account or a Uniform Gift to Minors Account. The purpose of this type of arrangement is to provide oversight of the asset until the child reaches the age of majority in the state. One issue that comes up with gifts to minors (and to those under age 24) is what is called the “Kiddie Tax”. The “Kiddie Tax” may limit the tax benefit from this income shifting opportunity by subjecting amounts of unearned income exceeding $2,000, in 2013, to taxation at the applicable parent’s tax rate.

This shifting assets (income) strategy also is designed to take assets that might be taxed upon death at an estate tax rate that might reach 40% and puts them into the hands of the beneficiary whose individual tax rates might be, today, perhaps as high as 43.4%. The ‘estate’ tax ‘individual’ tax rate differential obviously is not as compelling today (individual rate is higher than the estate rate) for the avoid estate taxation argument of inter vivos wealth transfers nonetheless they should be looked at depending on the facts of each situation. Additionally estates are not even taxed until they exceed $5,250,000 in 2013 so for most there will never be, lol, an estate tax to worry about.

An advantage to your receiving an asset after someone dies rather than having it gifted to you during their lifetime is that there is a step-up in value (presuming an increased value in the asset) to the value at the date of death. For example, if Mom was the last to die and she and Dad paid $100,000 for a home that you inherit when it is valued at $900,000 and you sell it for $900,000 there is no gain or loss. Under the gift scenario, based on these facts alone, the $800,000 gain would not be ‘stepped up’ so a tax would be due on that appreciated value upon a dispositive event – a sale. With respect to this ‘step up in value concept’, one should be aware that IRA’s, annuities, Pensions and Retirement Accounts that have never been taxed do not get a step up in basis.

So if we know we would not need an asset in our lifetime, or if we know that we are dedicating an asset for a specific life expenditure occurring at some date in the future (college, bar or bat mitzvah, etc.), would we benefit from shifting that asset, and the income thereupon, to another in order to most optimally accumulate funds for our dedicated expenditure purpose? Would that give us more available for the expenditure or, perhaps, give us the amount needed sooner? Should we do this type of thing now, and if not, when? In doing so, would we be putting assets into the hands of someone, a child for example, who then would be precluded, for example, from getting financial aid for school because they ‘owned’ too much in assets? Would the asset transferred become subject to the control or potential attachment of another? There are lots of causes and effects to any strategy hence the need to think not only of tax optimization but asset preservation and protection.

EMPLOYING FAMILY MEMBERS IN A BUSINESS OR IN THE HOUSEHOLD

If we have a business, or if we have a housekeeper or maintenance worker (gardener), rather than employing other than a family member to work in those activities, we could employ our child, family member, or related children in doing that work. An advantage to employing family members in our business or in our household is that they will have earned income shifted to, or earned by, them by being paid a wage. Earned income can be excluded from taxation up to the amount of our personal exemption and standard deduction. So for a 16 year old child claimed as a dependent on her parent’s tax return helping with filing and office clean up during the year in Mom’s business they could earn $6,100 + $1,000 in income and not pay any taxes on that income. With just $6,000 of ‘earned’ income the child could fund a Roth IRA which would not be a tax deduction to the child but it wouldn’t be needed as such anyway. The advantage to a Roth over other types of IRAs is that you can access your contributions to a Roth IRA at any time. You do not have to wait five years. You do not have to wait until age 59 ½. Contributions to Roth’s can be accessed at any time, earnings on Roth’s, however, are another story.

Even if there is not a business for a child to work in they certainly can do work around the home, do gardening or do baby-sitting, for example, all of which are examples of earning ‘earned’ income in a household doing domestic services. Of course, unlike the business activity, employment of your children in the household would not provide a tax deduction to the family just like the gardener or pool man is not deductible to the family today. For certain businesses employing under age 18 family members there may even be payroll taxes avoided (See Pub 15 Page 12).

CONCLUDING THOUGHTS

Making the most of what we are able to earn and keep for ourselves is so important to families today. Parents who have worked their whole lives to have what they have want to ensure what they have earned and accumulated is most fully shared by those they wish to benefit. Having income or transfer taxes eat up what we have or are able to acquire is a terrible thing if it can be avoided. Making the best of good family tax strategies is a wonderful thing. Take the time to think about your fiscal responsibilities and life’s expenditures and see if you are optimizing your resources for them.

David Bergmann, CFP®, EA, CLU, ChFC
Managing Principal
The David Bergmann Group
Marina Del Ray, CA


3 Comments

Keeping What You Make – Managing Taxes Owed on Income Received


The Debt Crisis Isn't Over YetTax Rates Overview

Under our current tax code, The Tax Act of 1986, as amended to date, the income that we earn for income tax purposes can be subject to either ‘no taxation’, ‘regular income taxation’, or an ‘alternative rate of taxation’ known as capital gains rates.

For some taxpayers the regular income taxation rate will be defaulted to a ‘parallel’ tax system known as the Alternative Minimum Tax (AMT) and an alternative tax rate on that income which is a flat tax rate of 26 or 28%.

For individuals who are not subject to AMT, their income would be subject to one of the following tax rates – 10%, 15%, 25%, 28%, 33%, 35% and 39.6% ($400,000 single or head of household or $450,000 if married filing jointly). Well technically one who is subject to the 33% tax rate, for example, is subject to each of the 10, 15, 25, and 28% tax rates because we have a progressive tax system that taxes us at various levels as we fill up those lower income tax rate buckets with income. If we took each bucket’s tax and related income number, we could calculate a weighted average tax paid from all of those buckets of income and we would call it the taxpayer’s ‘effective tax rate’. The lower one can get that effective tax rate for a given level of income, the better one will have done to ‘manage’ their tax liability on income.

For taxpayers making over $200,000, as single or head of household, and $250,000, as married filing jointly there will be an additional 3.8% tax on investment income which could be either (1) regular income, called ordinary income, like interest earned, (2) qualified dividend income, like income on your NYSE traded stock, or (3) capital, like capital gains. This new 3.8% tax will alter how we manage our income resources for those at these income levels.

Capital gains and qualified dividend taxes could be 0%, 15%, 20% (taxpayers making over $400,000 single or head of household and $450,000 married filing joint), 25% (real property depreciation unrecaptured gain) or 28% if a collectible is sold at a gain.

Social Security income is tax free if we do not earn too much income so for those who are receiving social security benefits managing income and the taxability upon it is crucial. Too much income annually is defined by the IRS as $25,000 for single, head of household, qualifying widow or widower with a dependent child or married individuals filing separately who did not live with their spouse at any time during the year; $32,000 for married couples filing jointly; and $0 for married persons filing separately who lived together at any time during the year. For every dollar of income earned over those thresholds a dollar of otherwise tax free social security benefits becomes taxable. For a taxpayer in the 35% tax bracket, for example, the loss to taxes from social security benefits becoming entirely taxable would be 32 cents on a dollar – (85% maximum of benefits that could be taxed) times (35% the marginal tax bracket). The least amount of benefits that could become subject to taxation if you go over the threshold is 50%.

3.8% Investment Tax Effect

Interest Income from a bond taxable at 35% or interest free? What is better? The formula for determining net yield after tax would be (yield) minus [(yield) times (tax)]. So to determine the tax equivalent of a municipal (tax free) bond to a corporate bond we would divide the tax free yield by (one) minus (marginal tax rate). For example, before the 3.8% extra tax a taxpayer in the 35% tax bracket would have been indifferent between a corporate bond that paid 5% and a tax free bond that paid 3.25%. Now, after the 3.8% additional tax is imposed, the same taxpayer earning the taxable 5% would be indifferent if the tax free rate was only 3.07%. Alternatively stated, to earn the equivalent of a 3.25% tax free, now the taxpayer would be looking for a taxable bond earning 5.29%.

Strategy Considerations

For Investment Income: Interest, Qualified Dividends and Capital Gains

The first thought is to re-allocate your CD type money into a dividend paying stock. For a single person in the 28% tax bracket ($87,850 to $183,250) that would save .13 cents on every dollar of earnings (.28 – .15). For a single person in the 15% tax bracket ($8,925 to $36,250) that would save .15 (.15 – 0) cents on every dollar. But is that penny wise and pound foolish? It might be because unlike your CD investment where your principal is secure, and most likely FDIC protected, the stock price associated with your investment paying that dividend may decline. A 1% negative move in a $20 dividend paying stock, 20 cents, would wipe out the tax gain you were trying to achieve by seeking out dividend income over ordinary income. So consider both your personal ability to tolerate risks of loss and determine the appropriateness to your financial circumstances of putting your principal to that risk.

To ensure that your capital gains get the favorable 0, 15%, or 20% (plus 3.8%, if applicable) tax treatment the investment must be held for more than one year. Knowing that the market does not go straight up, it might not be appropriate to seek capital gains by investing in the stock market if the money you are investing might be needed in the short to intermediate term – 3 to 5 years. Again, risk tolerance and diversification should always be taken into consideration.

For those subject to the 3.8% tax muni bonds can avoid that tax so they have become somewhat more attractive (as illustrated above a tax free rate of 3.25 is now equivalent to 5.29% rather than 5% without that tax being imposed. There are a significant number of strategies with regard to the 3.8% tax so consult with your advisor if you are subject to the tax.

For Social Security Taxability

When one is receiving social benefits it is even more important to manage the timing and character of income (ordinary, tax free, capital) so that one minimizes the impact of taxation on those benefits. Municipal bond income is tax free but it is considered taxable for purposes of determining whether or not, and how much of, your social security benefits could become taxable. To the extent the muni bond can provide more income than the taxable bond considering all of these factors it may (always run the numbers) be a tax optimizing investment choice when one is drawing social security benefits. Alternatively, an investment that provides cash flow without large taxable components to the cash flow might be a very good strategy to manage social security benefit’s taxability. An immediate annuity purchased with after tax dollars will have an exclusion ratio to the payments received that will then provide cash flow without taxation.

Concluding Thoughts and Observations

Wealth accumulation and wealth management require vigilance in both tax and portfolio risk management from the investment perspective. Tax rates have a huge impact on our net returns so strategizing for optimizing our tax impact with consideration of our own risk tolerance, and need to take risk, if any, for investment returns is an ongoing responsibility. Choices of tax-free, tax deferred, ordinary or capital gains income are very important in achieving optimal results with our resources earned over our lifetime. I hope you are maximizing and keeping all that you have worked so hard to earn.

David Bergmann, CFP®, EA, CLU, ChFC
Managing Principal
The David Bergmann Group
Marina Del Ray, CA


31 Comments

Keeping What You Make – Managing Taxes Owed On Income Received


What I Learned From the Tax SeasonTax Rates Overview

Under our current tax code, The Tax Act of 1986, as amended to date, the income that we earn for income tax purposes can be subject to either ‘no taxation’, ‘regular income taxation’, or an ‘alternative rate of taxation’ know as capital gains rates.

For some taxpayers the regular income taxation rate will be defaulted to a ‘parallel’ tax system known as the Alternative Minimum Tax (AMT) and an alternative tax rate on that income which is a flat tax rate of 26 or 28%.

For individuals who are not subject to AMT, their income would be subject to one of the following tax rates – 10%, 15%, 25%, 28%, 33%, 35% and 39.6% ($400,000 single or head of household or $450,000 if married filing jointly). Well technically one who is subject to the 33% tax rate, for example, is subject to each of the 10, 15, 25, and 28% tax rates because we have a progressive tax system that taxes us at various levels as we fill up those lower income tax rate buckets with income. If we took each bucket’s tax and income number, we could calculate a weighted average tax paid from all of those buckets of income and we would call it the taxpayer’s ‘effective tax rate’. The lower one can get that effective tax rate for a given level of income, the better one will have done to ‘manage’ their tax liability on income.

For taxpayers making over $200,000, as single or head of household, and $250,000, as married filing jointly there will be an additional 3.8% tax on investment income which could be either regular income, called ordinary income, like interest earned, or capital, like capital gains. This new tax will alter how we manage our income resources.

Capital gains taxes could be 0%, 15%, 20% (taxpayers making over $400,000 single or head of household and $450,000 married filing joint), 25% (real property depreciation unrecaptured gain) or 28% if a collectible is sold at a gain.

Social Security income is tax free if we do not earn too much income so for those who are receiving social security benefits managing income and the taxability upon it is crucial. Too much income annually is defined by the IRS as $25,000 for single, head of household, qualifying widow or widower with a dependent child or married individuals filing separately who did not live with their spouse at any time during the year; $32,000 for married couples filing jointly; and $0 for married persons filing separately who lived together at any time during the year. For every dollar of income earned over those thresholds a dollar of otherwise tax free social security benefits becomes taxable. For a taxpayer in the 35% tax bracket, for example, the loss to taxes from social security benefits becoming entirely taxable would be 32 cents on a dollar – (85% maximum of benefits that could be taxed) times (35% the marginal tax bracket). The least amount of benefits that could become subject to taxation if you go over the threshold is 50%.

3.8% Investment Tax Effect

Interest Income from a bond taxable at 35% or interest free? What is better? The formula for determining net yield after tax would be (yield) times (tax). So to determine the tax equivalent of a municipal (tax free) bond to a corporate bond we would divide the tax free yield by (one) minus (marginal tax rate). For example, before the 3.8% extra tax a taxpayer in the 35% tax bracket would have been indifferent between a corporate bond that paid 5% and a tax free bond that paid 3.25%. Now, after the 3.8% tax, the same taxpayer would be indifferent if the tax free rate was only 3.07%. Alternatively stated, to earn equivalent of a 3.25% tax free now, the taxpayer would be looking for a taxable bond earning 5.29%.

Social Security Income Taxability Management

When one is receiving social benefits it is even more important to manage the timing and character of income (ordinary, tax free, capital) so that one minimizes the impact of taxation on those benefits. Municipal bond income is tax free but it is considered taxable for purposes of determining whether or not, and how much of, your social security benefits could become taxable. To the extent the muni bond can provide more income than the taxable bond considering all of these factors it may (always run the numbers) be a tax optimizing investment choice when one is drawing social security benefits. Alternatively, an investment that provides cash flow without large taxable components to the cash flow might be a very good strategy to manage social security benefit’s taxability. An immediate annuity purchased with after tax dollars will have an exclusion ratio to the payments received that will then provide cash flow without taxation.

Concluding Thoughts and Observations

Wealth accumulation and wealth management require vigilance in both tax and risk management from an investment perspective. Tax rates have a huge impact on our net returns so strategizing for optimizing our tax impact with our own risk tolerance, and need to take risk, if any, for investment returns is an ongoing responsibility. Choices of tax-free, tax deferred, ordinary or capital gains income are very important in achieving optimal results with our resources earned over our lifetime. I hope you are maximizing and keeping all that you have worked so hard to earn.

David Bergmann, CFP®, EA, CLU, ChFC
Managing Principal
The David Bergmann Group
Marina Del Ray, CA


2 Comments

The ‘Last’ Estate Plan


Make Money a Servant to Your LifeNow that you have diligently and thoroughly thought out your estate plans and have visited your attorney to legally document those estate plans …

Have you thought about the details of your final ‘good-bye’?

In many cases personal items that you wish to have passed to particular people or organizations will need to be specifically identified and your intentions documented to make sure that the personal item goes to whom you wish. Perhaps a video walk-through of the home with items identified and history or stories of the item told will add extra ‘preciousness’ to the otherwise valuable keepsake or heirloom. It might help explain your choices to your legatees so that they would understand your choices rather than being uncertain about them or dissatisfied by them after your passing.

For some individuals, a legacy video is obtained wherein they talk about their family history, their life experiences and maybe most importantly, lessons learned and values ingrained. Things that perhaps we just never got around to talking about or saying but that we would like to share and make certain that they are passed on to those that follow us. As a client once told me with respect to his legacy – “I’d just like them to always remember that I did pass through …”

If you were to think about your final good-bye ceremony and the involvement of family and friends to the extent desired …

  • What would the service be like and where would it be held?
  • Would it be just a service or a service and reception?
  • Who would be in attendance (and maybe who should not) and what time of day would it be?
  • Would a clergy or other specifically identified individual(s) preside over the service?
  • Would you be cremated or ??
  • What sort of expense would you think was appropriate for the service, for your casket, for your urn, for ??
  • Would there be any particular organizations that would be involved in the services like the military?
  • If donations were to be made, where would you like them made to?
  • Would there be any specific readings, scriptures, hymns or music to be used in the service? If so, would there be any particular order or place in the service that you would like them used?
  • If a casket is chosen, would you want an open casket service?
  • Would your grave site be on a hill, under a tree or in a mausoleum?
  • What would your tombstone say?
  • Who would be your pallbearers?
  • Would there be a special suit or dress that you would like to be buried in?
  • If an obituary were to be written, who would write it?
  • Any special wishes that haven’t been thought of that you have in mind?
  • Where would your family find your ‘important’ documents and will you have made them aware of that information in advance of your passing?

I don’t know where, or if, any of these considerations will come to play in your life’s passing event, but, hopefully I have given you some food for thought on this often overlooked matter of our final affairs. Having expressed our desires to those who would be making these kinds of decisions can be extremely helpful for them as they try to honor you ‘completely and respectfully’ as they would like for your celebration of life to be deservedly done for you.

May your life be abundant and fulfilled. When the time comes I hope your passing is peaceful and that you have support around you. Let that ‘last estate plan’ celebrate your memory and legacy as you would have it memorialized.

David Bergmann, CFP®, EA, CLU, ChFC
Managing Principal
The David Bergmann Group
Marina Del Ray, CA


2 Comments

Paragliding Off the Fiscal Cliff


Asset-Allocation-in-a-CrisiWell the fiscal cliff, much like the Mayan calendar, and much like Y2K, was just another non-event. A lot of buzz with even a lot more fizzle. The sun has risen, aircraft are safely landing and football dominates the thinking of sports minded folks as we all enjoy the first day of the New Year and the rest of our, hopefully long, lives! Not to downplay the significance of what could have happened had all things remained unsettled and all provisions of previous tax and budget agreements been exercised, just a comment on how often we hear that the World is coming to an end only to find that through all the huffing and puffing nobody’s house was blown down.

Soon we will learn more about the specifics of the 11th hour agreement and we will then hear lengthy discussions from the media and others about how ‘the can just got kicked down the road’! Yes, there are components of the bill that will be ‘permanent*’ but there will still be budget deficit ceiling negotiations, tax reform* discussions and entitlement reform to deal with in the next two months before we can say we have our fiscal house in order, whatever that may look like, remembering that there are differences in opinions about balanced budget management requirements versus budget deficit flexibility, etc., etc. etc.

The Tax Policy Center has estimated, as a result of the Taxpayer Relief Act of 2012, an average annual ‘pocketbook’ hit depending on the following levels of taxpayer income …

$20,000 to $30,000 $297
$30,000 to $40,000 $445
$40,000 to $50,000 $579
$50,000 to $75,000 $822
$75,000 to $100,000 $1,206
$100,000 to $200,000 $1,784
$200,000 to $500,000 $2,711
$500,000 to $1,000,000 $170,341

[Chart courtesy of LA Times, author Alana Semuels]

Taxes on Earnings
Payroll. Everyone will feel the loss of the 2% payroll tax holiday starting January 1, 2013. If you make more than $200,000 (single) or $250,000 (married filing jointly) you will also feel the PPACA (Obamacare) 0.9% additional ‘health care’ tax taken from your paycheck.

‘Ordinary Income’
Wages and interest income (as well as short term capital gains) will be taxed at the ordinary tax rate brackets which will remain the same as prior years (Bush tax cuts) except for individual taxpayers earning over $400,000 or married taxpayers earning over $450,000. Those taxpayers will see their tax rates go as high as 39.6%. For individuals earning more than $200,000 and married couples earning more than $250,000 there will be a 3.8% ‘health care’ tax added to the taxes paid at ordinary rates for interest income earned (and short term gains but not for wages).

‘Capital Gains and Dividends’
The good news here is that capital gains (long term) and dividends will both still get favorable capital gains tax rate treatment of 0% or 15% if your income is under the $400,000/$450,000 level. If your income is over those amounts, a capital gain maximum rate of 20% will apply. Let’s not forget, however, that the 3.8% ‘health care’ tax ($200,000/$250,000 income levels) comes into play here as well making the potential capital gains rate for those making more than the $400,000/$450,000 a maximum 23.8%.

Alternative Minimum Income Tax (AMT)
This is a break, if you can call anything about AMT a break. For each of the past several years tax preparers have had to wait until the last minute for Congress to come up with a statutory AMT exemption amount (it is like our standard deduction that we have for regular tax purposes) so that we would know who would or would not become subject to AMT. If Congress had not upped the 2012 exemption amount to $78,750 for married couples and $50,600 for individuals, a married taxpayer could have had to pay, perhaps, as much as $8,775 more in taxes in 2012 [$78,750 - $45,000)(.26)].

Itemized Deductions and Personal Exemptions
A couple of years ago there was an income phaseout employed to reduce the benefit a higher income earning taxpayer would get from itemized deductions and personal exemptions. That phaseout for itemized deductions is being brought back for 2013 and will start at $250,000 for individuals, $275,000 for head of household and $300,000 for married filing jointly. Personal exemptions will have the same phaseout dollar filing status threshold amounts, again, for tax years 2013 and thereafter.

Potpourri.
Extended through 2013

  • Tax free distributions from IRA to charity
  • Educator expenses
  • State and local sales tax deduction
  • Debt relief income recognition exemption for qualified residence indebtedness
  • Variety of energy tax credits for energy efficient homes and energy-efficient appliances.

Extended for five years

  • Enhanced earned income credit
  • American opportunities credit

Extended permanently

  • Child tax credit of $1,000

Estate tax

  • Estates that exceed $5,000,000 will see the estate tax rate increase to 40%
  • Annual gift tax exclusion amount is $14,000 per individual for 2013

Again, the good news is that we didn’t end up like Thelma or Louise and we didn’t experience the thrill of a bungee-cliff-dive, both very good things. The bad news is that we seriously need to bring all sides together to address long term fiscal soundness through tax, entitlement and budget reform. All in all this Taxpayer Relief Act of 2012 is very modest in tax law changes and tax savings so a lot of work will need to be done in the next two months. Let us hope that this year’s group of elected officials can get the job done! Happy New Year to All!

David Bergmann, CFP®, EA, CLU, ChFC
Managing Principal
The David Bergmann Group
Marina Del Ray, CA


1 Comment

Nine Candles or Twelve Days Of


Whatever Holiday you and your family celebrate this time of year we at the Financial Planning Association wish you a joyous Holiday Season. For those still working through community storm damage or personal situations that life always seems to bring our way we hope that the proverbial ‘light at the end of the tunnel’ will see your delighted emergence soon.

‘Year End Financial Planning Presents for You’
Here are some for you to unwrap and enjoy.

  • Gifting. As we think about gifting to our local place of worship, our alma mater, or to a cause we support, are we optimizing our gift to charity? Giving cash allows us a tax deduction but giving appreciated stock of the same value gives us the same tax deduction (for the most part) that giving the cash did but we also might avoid the capital gains taxation. So in general, it is better to give gifts of appreciated property when we are thinking of gifting.

We can gift $5,120,000 in 2012 without paying gift taxes even though we would have to file a gift tax return to claim the $5.12M gift tax exclusion. For those capable and for whom the transfer is appropriate, this is an unprecedented wealth transfer opportunity that will sunset December 31st of this year. Alternatively, we can gift $13,000 per individual in 2012 without having to pay a gift tax or having to file a gift tax return. Learn more about Charitable Contributions at www.irs.gov/pub/irs-pdf/p526.pdf.

  • Investment Tax Management. As the year closes, as we always do, we should look over our portfolio to see if there are any tax losses or tax gains that would be appropriate to recognize before the year end. This year end is particularly important given the potential change in capital gains taxes and the health care taxes on investment income that are coming. It might be appropriate to recognize a gain this year even though your intent is to hold the asset for more than a short term period. As always, never let the tax tail wag the investment dog, run the numbers to see what the appropriate strategy is for you. Learn more about Investment Income and Expenses at www.irs.gov/pub/irs-pdf/p550.pdf.
  • Retirement Tax Management. If it would benefit you, the last day to set up a 401k plan for your business activity is December 31st. You can fund the amount by the tax due date, plus extensions, but it must be set up by the December 31st deadline. If it would benefit you, December 31st is the last day that a defined benefit plan can be established. It has the same funding time requirements as the 401k. You can still establish an IRA up to April 15th (or tax due day if different) but it has to be funded by the due date.

Converting a Traditional IRA to a Roth IRA before December 31st might be considered. A few of many factors to consider are:

    • the tax hit you take today to get the tax free (under current law) benefit you are paid later and will you be better off and
    • where will those taxes be paid from today to make the conversion – from the IRA or from ‘outside’ assets like your personal savings account.

Learn more about Retirement Plans for Small Business at www.irs.gov/pub/irs-pdf/p560.pdf.

  • Estate Planning. Take a moment to review your beneficiary designations on your retirement accounts, annuities, life insurance contracts, or any other beneficiary ‘capable’ asset to see if your testamentary intentions are still the same. If you haven’t had your living trust or estate plan reviewed in a while you may want to make sure they still have legal effect and that Advanced Directives are HIPAA compliant. Stay tuned to what our legislators have in mind with respect to estate taxation when a tax agreement comes about. Estate tax laws revert to prior law unless Congress takes affirmative action. That would mean, again, barring action that estates in excess of $1 million would be subject to a 55% tax rate next year (35% top rate in 2012). Learn more about Estate and Gift Taxes at www.irs.gov/pub/irs-pdf/p950.pdf.
  • Wealth Management. My fellow FPA blogger, Mary Beth Storjohann, provides us a great blog on her thoughts on Holiday spending (http://blog.fpaforfinancialplanning.org/2012/11/16/ingredients-for-holiday-spending-success/). We are so tempted by the spirit of the Season to indulge ourselves and why not! We should be able to enjoy the spoils of our labors with some indulgences but we do need to be financially prudent. I know for me, just the time with family, or the gift of a ‘mini’ weekend vacation with all of us together, is, as the advertisement says, priceless. What would that ‘priceless’ gift be for you? I hope it is in the gifts to you this year!

Have a wonderful Holiday Season and a fabulous New Year!

David Bergmann, CFP®, EA, CLU, ChFC
Managing Principal
The David Bergmann Group
Marina Del Ray, CA


2 Comments

Casualty Losses and Disaster Preparedness


For those living on the Eastern seaboard still cleaning up from Hurricane Sandy, we at the Financial Planning Association, wish you and yours well during this difficult rebuilding time. Although, thankfully, not a ‘hurricane’ magnitude like Katrina, Sandy demonstrated that we can never under estimate the power of Mother Nature to do damage! So we are always reminded to take appropriate safeguards before, during and after the casualty or disaster event.

Before
A good personal risk management regimen should always include an annual review of your personal and business insurance coverage to ensure that dollar amounts of coverage are sufficient for risks that you or your business might be exposed to. Not only do we want to know how much coverage we have, we also want to know what our deductibles and co-pays are so that we know what kind of a ‘hit’ our cash flow would take before coverage commences if we were to sustain some sort of loss. Property damage, liability insurance and personal content are standard provisions of auto and home policies but what about coverage for ‘collectibles’, ‘valuables’ or other special risk exposures to property or assets like flood, earthquake or other natural disaster(s)? Rather than writing an inventory of everything we have in our home, do we have a video of all those things in our home to help us with substantiating a loss should we incur one? Like with changing the batteries in your smoke detectors in the home annually, review your risk management needs to see if you have the right insurance coverage and if there might be cost savings to coordinating policies. Make sure what you want to be insured in fact is insured – that dirt bike you use off road on the weekends or those jet-skis the kids use on the lake.   As stated above, review deductibles and or cost sharing obligations of your coverage to ensure that (1) you are not buying too much first dollar of out of pocket coverage, weighed by (2) the ability of your cash flow and emergency funds to sustain a major disaster recovery hit.  If you live in low lying areas that could be subject to flooding (again, natural disasters), you will find that homeowner’s policies generally do cover flooding you should consider buying that coverage separately.  You may find that the sequence of the events that cause the destruction may cause difficulty in triggering coverage i.e. “did the fire cause the flooding to occur or did the flooding cause the fire to occur.”

During
As a survivor of ground zero during the Northridge Earthquake of January 17, 1994 at 04:31 am, yeah, you don’t forget stuff like this; I don’t think I can say much more than you already know for yourself — BE SAFE! Make sure your loved ones are ok, that gas lines have been shut down and look out for live electric wires, wavering or fallen objects, glass and sharp objects, etc. etc. Be glad that you have been prepared by sleeping with that flashlight and hard bottomed shoes next to your bed. Make sure your post-event energy supplies are protected so that in the event of power outages you will be able to have some power for essentials.

Make sure your emergency preparedness kit is with you and initiate your disaster plan as you had prepared it following contingency plans, if required. Having to endure a disaster might be out of our control but having had the opportunity to prepare for one, even an earthquake, is not.

After
Once the casualty event or disaster has passed and we ‘emerge’ from our ‘safe place’ we will want to secure property, if we are able, from sustaining any additional damage. Taking a post event video to compare with the pre event video mentioned above is a great tool for filing for losses. Most homeowner’s policies will have temporary, if needed, living expense provisions and every carrier will have claim adjustors and other representatives on site as quickly as possible to move your recovery along. You have rights to seek independent help with assessing your damages and valuing your claim but in most of my experiences, both personally and with what I have seen with clients, carriers have been, again for the most part, fair in their payouts. Look out for individuals or companies that come to take advantage of those in desperate need. Unlicensed contractors, price gougers and the like will be there to take advantage of that urgent nature of your need so please be careful and protect yourself from being taken advantage of!

If you are in need financially or otherwise, there are many disaster relief or aid organizations out there. FEMA is the major federal source of disaster relief but do not overlook other State or Local benefits that might be available, such as the County’s Housing Authority or similarly named Department. In Los Angeles the LA Housing Authority made funds available for post-earthquake repair to those who qualified. Additionally, the Employment Development Department extended unemployment benefits to those whose workplace needed to be rebuilt before the employees could return to work.

Casualty losses not covered by insurance might get you some tax relief by allowing you a Casualty Loss Deduction. The ‘tax mechanics’ of the deduction will differ depending on whether the ‘loss’ property was a business asset or a personal asset, but nonetheless, there may be some ‘tax benefit’ you will get.

Conclusions
In any case, the most important thing to remember about a casualty or disaster is that it is not our possessions and material holdings that matter the most but rather it is the wealth of love and life that we get from having family and friends around us that we care about and with whom we are comforted. Wishing you and those around you the very best – BE SAFE AND HAPPY HOLIDAYS TO ALL !

David Bergmann, CFP®, EA, CLU, ChFC
Managing Principal
The David Bergmann Group
Marina Del Ray, CA


3 Comments

Year End Tax Planning – Part Two – Business


Year-end tax considerations for businesses are not quite as up in the air as is the individual tax situation so let’s take a look at a few of them.

Will the 3.8% Net Investment Income Tax Come Into Play?
With respect to that 3.8% net investment income tax coming in 2013, don’t worry, the tax doesn’t apply to income from trades or businesses conducted by a sole proprietor, partnership, or S corporation. But income, gain, or loss on working capital isn’t treated as derived from a trade or business and thus is subject to the tax.  Additionally, gain or loss from a disposition of an interest in a partnership or S corporation is taken into account by the partner or shareholder as net investment income and, therefore, could cause the 3.8% tax to apply.

Considering Buying Equipment?
Current law allows you to ‘write-off’ (expense), up to $139,000 of qualifying property placed in service in the tax year. If you have already placed in service $560,000 of qualifying property this strategy will not work because for every dollar of qualifying assets that you place in service above this level you lose a dollar of ‘expensing’ benefit. If you haven’t exceeded the maximum yet, and you need the machine but do not have the cash, put the purchase on your credit card that will qualify it as having been purchased this year. You can also get substantial write-offs in 2012 from a purchase of a more than 6,000 pound vehicle that may be used in a trade or business.

Do you need to ‘shelter’ income or want to save for the future?
Setting up a retirement plan is fairly easy. The costs of a plan can be very minimal or they can get very expensive if you want ‘tailored or targeted’ plan design or a, so-called defined benefit plan, which has annual actuarial costs and other expense factors. Without going into details regarding selection or design factors let’s look at some of the basic choices for retirement plans other than an individual retirement account …

Plan Type:   Simple
Establish Date:  October 1st  
Fund By Date:  Due date return + Extension
Max. if <50 yrs. old:  $11,500 + 3% or 2%

Plan Type: 401 (K)
Establish Date:  December 31st
Fund By Date:  Due date return + Extension
Max. if <50 yrs. old:  $16,500 + 25%*

Plan Type: Defined Benefit
Establish Date: December 31st
Fund By Date: Due date return + Extension
Max. if <50 yrs. old:  Actuarially Determined

Plan Type: SEP
Establish Date:  Due date of return + Extension
Fund By Date: Due date of return + Extension
Max. if <50 yrs. old: $49,000 (25%* of comp)

[*Note that 25% is actually 20% because it is 25% of income ‘in respect of’ (after) the deduction so $100,000 of income minus $20,000 =’s $80,000.   $20/$80 is 25%]

Need Employees?
If you are thinking of hiring, consider hiring a veteran before year-end to qualify for a work opportunity credit. The credit, a dollar for dollar reduction in tax liability, can range from $2,400 to $9,600 depending on a variety of factors.

Are you a Corporation?
If you are incorporated, you may want to consider a stock redemption (buy-back) which may, depending on a multitude of factors, create a long-term capital gain or a dividend which will receive the favorable 15% tax rate if done this year. Remember, unless Congress acts, capital gains rates will be going up and that 3.8% net investment income tax could apply if you make more than $250,000 married, $125,000 married filing separately and $200,000 individually.

Are you a Partnerships or a S-Corporation?
When our ‘amount at risk’ in an activity is not sufficient to allow us to, possibly, take a loss from an activity, our loss will be ‘suspended’ until such time as we have sufficient amounts ‘at-risk’. If you might not be able to utilize a loss currently because you didn’t have sufficient amounts ‘at-risk’, consider adding capital, or, alternatively, if possible, add debt that you are ‘personally responsible for’ to the activity which, by definition, will increase your at-risk. That will allow you, then, to take the loss currently. Remember, though, if this is a passive activity, there are other hurdles to overcome in order to take a ‘passive loss’ currently.

Closing Thoughts
These are but a few of the year end considerations. For 2013 ‘larger’ small businesses who offer health care to their employees, or even those that do not offer health care to employees currently, will need to review provisions of the Patient Protection and Affordable Care Act to determine the tax impact of the Act on their benefit plans and what course of action might be most prudent to pursue with respect to benefit plan(s) design for the business.

I hope that your 2012 tax year was a good one for you, your family and your employees, and I hope that 2013 is even better for ALL!

David Bergmann, CFP®, EA, CLU, ChFC
Managing Principal
The David Bergmann Group
Marina Del Ray, CA

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