tax smart actions you can take throughout the year - fidelity … · 2019. 10. 11. · ira has high...
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Tax smart actions you can take throughout the year
10 September 2019
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The benefits of being tax-smart throughout the year
Agenda
► Contributing to an IRA to help reduce
your taxes and put money away for
retirement
► How a 529 plan can fit into your plan
► State tax residency planning
The benefits of being tax-smart throughout the year
IRAs
The benefits of being tax-smart throughout the year
Traditional Roth
Contributions Pre-tax/deductible* After-tax
Tax-deferred growth Yes Yes
Tax benefits Now* Later
*IRA contributions may or may not be deductible depending on individual circumstances
Comparing traditional and Roth
The benefits of being tax-smart throughout the year
IRAs: Eligibility and contributions
Traditional IRA Roth IRA
Ability to
Contribute
► Must have earned income
(non-working spouse is eligible to contribute)
► Must have earned income
(non-working spouse is eligible to contribute)
►2019 AGI Phase Out
►Single & HOH: $122,000 - $137,000
►MFJ: $193,000 - $203,000
Maximum
Contributions
►$6,000
►$1,000 catch-up for those age 50+
Contribution
Deductibility
► 2019 AGI Phase Out – You
►Single & HOH: $64,000 - $74,000
►MFJ: $103,000 - $123,000
► 2019 AGI Phase Out – Spouse
►MFJ: $193,000 - $203,000
►Not deductible
Taxation of
Distributions
►Ordinary income on before-tax contributions
and earnings
►10% penalty may apply if under age 59 ½
►Tax-free qualified distributions
►Non-qualified distributions may be subject to
tax and/or penalty
The benefits of being tax-smart throughout the year
Three good reasons to contribute to a traditional IRA
1. You want to deduct your
IRA contributions
2. You expect to be in a lower
tax bracket in retirement
3. You can’t fully contribute to
a Roth IRA
The benefits of being tax-smart throughout the year
Four good reasons to contribute to a Roth IRA
1. Your employer doesn’t offer a
401(k), or offers one without a
Roth feature
2. You expect to be in a higher tax
bracket in retirement
3. Your ability to deduct traditional
IRA contributions is limited or
prohibited
4. You prefer not to be subject to
RMDs
The benefits of being tax-smart throughout the year
• Catch-up contributions for those age 50+
• Spousal IRA available for non-working spouse
• Contributions can be made through April 15 of the following year
– Traditional: tax-deferred growth and possible current year tax deduction
– Roth: tax-free retirement income; no current year tax deduction
Contributions
• Ordinary income tax on pre-tax contributions and earnings during the year of conversion
Roth Conversion
IRA opportunities
The benefits of being tax-smart throughout the year
Roth for children
► Gift up to $6,000 to children
► Do they have earned income?
► Are they under income limitations (MAGI)?
► Single: $122,000 - $137,000
► MFJ: $193,000 - $203,000
► Roth IRA qualifies for annual gift tax exclusion but provides some potential protection for assets from kids being kids
The benefits of being tax-smart throughout the year
Roth conversion
The benefits of being tax-smart throughout the year
What is a Roth conversion?
A transfer of assets from
a traditional account
to a Roth account► Balances are thereby “converted”
to a Roth account
► Once converted, balances in the
Roth account enjoy all the
features of a Roth
The benefits of being tax-smart throughout the year
What are the tax implications at the time of a Roth conversion?
Pretax balances and
earnings are subject to
ordinary income taxes
No tax penalty regardless
of age
The benefits of being tax-smart throughout the year
Roth conversions: Point counterpoint
► Owner can pay the tax on conversion from
non-account assets
► Assets will pass to non-charitable beneficiaries
► When the investment horizon is longer and/or
wealth transfer to heirs is a priority
► Assets will appreciate
► When the owner anticipates that their income
tax rates will stay the same or increase
► Owner needs to take a distribution from the IRA
to pay tax on conversion
► Assets will be used to fund charitable bequests
at death
► When the investment horizon is shorter
(e.g. assets will be spent in retirement)
► Assets will depreciate
► When the owner anticipates that their income
tax rates will decrease significantly
Conversion makes
more sense
Conversion makes
less sense
The benefits of being tax-smart throughout the year
Roth conversions: Point counterpoint
► High bracket taxpayer subject to AMT in year
of conversion
► IRA has high cost basis
► When IRA has low basis and owner has NOL,
large charitable deductions or other items that
will shelter the income from the conversion
► High bracket taxpayer who may be in AMT in
a subsequent year
► IRA has low cost basis creating significant tax
liability on conversion
Conversion makes
more sense
Conversion makes
less sense
► Caution: Can no longer unwind a Roth IRA conversion
The benefits of being tax-smart throughout the year
Marginal tax rate
The ever-changing tax landscape
The benefits of being tax-smart throughout the year
Highest rate Lowest rate
1926 1936 1946 1956 1966 1976 1986 1996 2006 20262016
20%
40%
60%
80%
100%
529 plans
The benefits of being tax-smart throughout the year
The average annual costs of college
$0 $10,000 $20,000 $30,000 $40,000 $50,000 $60,000
Public two-year in-district commuter
Public four-year in-state on-campus
Public four-year out-of-state on-campus
Private nonprofit four-year on-campus
Tuition Room and board Books and supplies Transportation Other expenses
Source: College Board, Trends in College Pricing, 2018
The benefits of being tax-smart throughout the year
Sources of college funding
Family income and savings
48%Scholarships and grants28%
Borrowing24%
Parents: 34%
Students: 14%
Scholarships: 17%
Grants: 11%
Students: 14%
Parents: 10%
Source: Sallie Mae, How America Pays for College, 2018
The benefits of being tax-smart throughout the year
College savings vehicles
529 savings plans
529 pre-paid plans
Coverdell education savings
accounts (ESA)
Series EE and I bonds
Custodial accounts
IRAs
Taxable accounts
The benefits of being tax-smart throughout the year
529 savings plans
Taxation► Contribution: Possible state tax
deduction
► Growth: Tax-deferred
► Distribution: Tax-free (if qualified)
Investments► Low fees
► Age-based, risk-based, and other
investment options
Other features► Low impact on financial aid
► Ability to change beneficiary
The benefits of being tax-smart throughout the year
Tax benefits of 529 plans
Savings grow tax-deferred
Federal tax-free withdrawals for
qualified education expenses
Beneficiary can be changed at
any time
Potential state tax savings on contributions
and withdrawals
The benefits of being tax-smart throughout the year
You can change the Beneficiary to someone who is recognized by
federal tax law as a family member of the original Beneficiary.
Qualified tuition programs – 529 plans
529 plans
College savings plans
Pre-paid tuition plans
The benefits of being tax-smart throughout the year
529 Pre-Paid Tuition Plans and 529 Savings Plans
529 Pre-paid Tuition Plans 529 Savings Plans
Objective• Lock in the current cost of education
• Save without bearing investment risk
Choice of investments to help accumulate assets
Eligibility Some states require residency
Contributions High contribution limits
Federal taxation• Tax-deferred growth
• Tax-free qualified distributions
• Tax-deferred growth
• Tax-free qualified distributions
Investment choices Plan bears the investment risk Determined by each plan
Control Owner maintains control
Effect on Aid5.64% included in Expected Family Contribution
(EFC) calculation, assuming parent is owner5.64% included in EFC calculation, assuming parent is owner
Other
• May be used at any qualifying school (benefit
may be less if used at a non-qualifying school)
• Non-qualified distributions of earnings subject to
ordinary income tax and 10% penalty
• May be used at any qualifying school
• Non-qualified distributions of earnings subject to ordinary income
tax and 10% penalty
When to consider
• Low tolerance to investment risk
• Believe cost of education will rise faster than
returns on investments
• Moderate to aggressive risk tolerance
• Long-term time horizon
• Want ability to save large sums
The benefits of being tax-smart throughout the year
State tax considerations
The benefits of being tax-smart throughout the year
What do you need to know about state income taxation of residents/non-residents?
► State tax rates generally
► How states tax residents and non-residents
► How various types of income are taxed
► What you need for filing state returns
► Planning opportunities
The benefits of being tax-smart throughout the year
State income tax rates
None Low (1–4%) Medium (4–7%) High (>7%)
Source: Federation of Tax Administrators
The benefits of being tax-smart throughout the year
State tax considerations – how states tax residents and non-residents
► What state(s) do you need to pay tax to?
► Resident taxation
► Domicile
► Statutory residency
► Non resident taxation
► Are there special rules for certain types of income?
► Non-resident taxation and income allocation
The benefits of being tax-smart throughout the year
Domicile generally
► What is domicile?► “Domicile, in general, is the place that an individual intends to be such individual’s
permanent home – the place to which such individual intends to return whenever such
individual may be absent.”
► A taxpayer may have several residences but can have just one domicile
► Generally, if a person is domiciled in a state, they will be taxed as a
state resident
► However, a person domiciled in a state may be treated as a
nonresident if: ► The person did not maintain a permanent place of abode in the state for the entire
taxable year;
► The person maintained a permanent place of abode outside the state for the entire tax year;
► The individual spent no more than 30 days in the aggregate in the state during the tax year.
The benefits of being tax-smart throughout the year
Statutory residency generally
► Statutory residency is generally an objective test
► It is a two-prong test:
► Maintaining a permanent place of abode within the state
► Issue: Client purchases a home for a family member but retains title in the client’s name
► Spending in the aggregate more than 183 days in state
The benefits of being tax-smart throughout the year
Non resident taxation
► States will generally tax the income of nonresidents which is “sourced”
to the state
► Rental income
► Gain on sale of real estate
► Compensation income
► Compensation income
► Allocation of income based on source and period earned
► Generally, only working days are considered in allocation
► See 4 USC §114. Limitation on state income taxation of certain
pension income
► Paying non-resident state income taxes
► Withholding
► Estimated payments
The benefits of being tax-smart throughout the year
State residency – planning tips
► Documentation, documentation, documentation
► Keep contemporaneous records and calendars
► Thoughtful planning on when change will be made
► Consideration of selling versus keeping home in higher tax state
► If more than two homes – how much time is spent in low tax state
versus state where you were formerly a resident
The benefits of being tax-smart throughout the year
Questions
The benefits of being tax-smart throughout the year