It’s Time to Review Your Financial Planning Options

Fall is a good time to pause and review your financial planning strategy. A lot can happen in a year. If your personal life, market conditions or tax laws have changed, you may need to revise your long-term financial plans. Here are some retirement and estate planning considerations that may be worthwhile.

IRS Proposal Threatens Discounts on Transfers of Family-Owned Business

For years, proactive taxpayers have used family limited partnerships (FLPs) and other family-owned business entities in estate planning. If properly structured and administered, these estate-planning tools allow high net worth individuals to transfer their wealth to family members and charities at a substantial discount from the value of entities’ underlying assets. Examples of assets that may be contributed to an FLP include marketable securities, real estate and private business interests.

Important Note. The FLP must be set up for a legitimate purpose (such as protecting assets from creditors and professional-grade asset management) to preserve valuation discounts.

Valuation discounts on FLPs relate to the lack of control and marketability associated with owning a limited partner interest. These interests are typically subject to various restrictions under the partnership agreement and state law.

The IRS has targeted FLPs and other family-owned businesses in various Tax Court cases. To strengthen its position in court, the IRS issued a proposal in August that could significantly reduce (or possibly eliminate) valuation discounts for certain family-owned business entities. Among other changes, the proposal would add a new category of restrictions that would be disregarded in valuing transfers of family-owned business interests.

If finalized, the proposed changes won’t go into effect until 2017 (at the earliest). So there still may be time to use these estate-planning tools and be grandfathered in under the existing tax rules. If you’ve been considering setting up an FLP or transferring additional interests in an existing one, it may be prudent to act before year end.

Contact your estate planning advisor for more details on this proposal — or to utilize this strategy before any new restrictions go into effect.

Roth IRAs

Do you understand the key differences between traditional and Roth IRAs? Roth IRAs can be an effective retirement-saving tool for people who expect to be in a higher income tax bracket when they retire. Here’s how it typically works.

You open up a Roth IRA and make after-tax contributions. The tax savings come during retirement: You don’t owe income taxes on qualified Roth withdrawals.

As an added bonus, unlike with traditional IRAs, there’s no requirement to start taking annual required minimum distributions (RMDs) from a Roth account after reaching age 70 1/2. So you’re free to leave as much money in your Roth account as you wish for as long as you wish. This important privilege allows you to maximize tax-free Roth IRA earnings, and it makes the Roth IRA a great asset to leave to your heirs (to the extent you don’t need the Roth IRA money to help finance your own retirement).

The maximum amount you can contribute for any tax year to any IRA, including a Roth account, is the lesser of:

  1. Your earned income for that year, or
  2. The annual IRA contribution limit for that year. For 2016, the annual IRA contribution limit is $5,500, or $6,500 if you’ll be age 50 or older as of year end.

If you’re married, both you and your spouse can make annual contributions to separate IRAs as long as you have sufficient earned income. For this purpose, you can add your earned income and your spouse’s earned income together, assuming you file jointly. As long as your combined earned income equals or exceeds your combined IRA contributions, you’re both good to go.

Unfortunately, your ability to make annual Roth contributions may be reduced or eliminated by a phaseout rule that affects high-income individuals. But you may be able to circumvent this rule by making an annual nondeductible contribution to a traditional IRA and then converting the account into a Roth IRA. In this indirect fashion, high net worth individuals can make Roth contributions of up to $5,500 if they’re under age 50 or up to $6,500 if they’re at least 50 and younger than 70 1/2 as of the end of the year. (Once you hit 70 1/2, you become ineligible to make traditional IRA contributions, and that shuts down this strategy.)

If you’re married, you can double the fun by together contributing up to $11,000 or up to $13,000 if you’re both at least 50 (but under age 70 1/2). There are various rules and restrictions to using this strategy, and it may be less advantageous if you have one or more existing traditional IRAs. So, consult with your tax advisor before attempting it.

Self-Directed IRAs

Self-directed IRAs expand the menu of investment options available in a typical IRA. For instance, with a self-directed IRA you may be able to include such alternatives as hedge funds, real estate and even equity interests in private companies. These types of investments often offer higher returns than traditional IRA investment options.

But self-directed IRAs aren’t a free-for-all. The tax law prohibits self-dealing between an IRA and “disqualified” individuals. For example, you can’t lend money to your IRA or invest in a business that you, your family or an IRA beneficiary controls. The consequences for self-dealing can be severe, so consult with your financial advisor before making the switch.

Deductible Losses on Underperforming Stocks

Do you own stocks and other marketable securities (outside of your retirement accounts) that have lost money? If so, consider selling losing investments held in taxable brokerage firm accounts to lower your 2016 tax bill. This strategy allows you to deduct the resulting capital losses against this year’s capital gains. If your losses exceed your gains, you will have a net capital loss.

You can deduct up to $3,000 of net capital loss (or $1,500 if you are married and file separately) against ordinary income, including your salary, self-employment income, alimony and interest income. Any excess net capital loss is carried forward to future years and puts you in position for tax savings in 2017 and beyond.

Gifts of Appreciated Assets

Suppose you are lucky enough to have the reverse situation: You own stocks and other marketable securities (outside of your retirement accounts) that have skyrocketed in value since they were acquired. Taxpayers in the 10% or 15% income tax brackets can sell the appreciated shares and take advantage of the 0% federal income tax bracket available on long-term capital gains. Keep in mind, however, that depending on how much gain you have, you might use up the 0% bracket and be subject to tax at a higher rate of up to 20%, or 23.8% when considering the Medicare surcharge that may apply.

While your tax bracket may be too high to take advantage of the 0% rate, you probably have loved ones who are in the lower tax brackets. If so, consider gifting them assets to sell.

Important Note. Gains will be considered long-term if your ownership period plus the gift recipient’s ownership period equals at least a year and a day.

Giving qualified-dividend-paying stocks to family members eligible for the 0% rate is another tax-smart idea. But before making a gift, consider the gift tax consequences.

The annual gift tax exclusion is $14,000 in 2016 (the same as 2015). If you give assets valued at more than $14,000 (or $28,000 for married couples) to an individual during 2016, it will reduce your $5.45 million gift and estate tax exemption — or be subject to gift tax if you’ve already used up your lifetime exemption. Also keep in mind that if your gift recipient is under age 24, the “kiddie tax” rules could potentially cause some of his or her capital gains and dividends to be taxed at the parents’ higher rates.

Charitable Donations

Charitable donations can be one of the most powerful tax-savings tools because you’re in complete control of when and how much you give. No floor applies, and annual deduction limits are high (20%, 30% or 50% of your adjusted gross income, depending on what you’re giving and whether a public charity or a private foundation is the recipient).

If you have appreciated stock or mutual fund shares that you’ve owned for more than a year, consider donating them instead of cash. You can generally claim a charitable deduction for the full market value at the time of the donation and avoid any capital gains tax hit.

If you own stocks that are worth less than you paid for them, don’t donate them to a charity. Instead, sell the stock and give the cash proceeds to a charity. That way, you can generally deduct the full amount of the cash donation while keeping the tax-saving capital loss for yourself.

Life Changes

Have there been any major changes in your personal life, such as a recent marriage or divorce, the birth or adoption of a new child, or a death in the family? If so, you may need to revise the beneficiaries on your retirement accounts and life insurance policies. You also may need to update your will and power of attorney documents.

Life changes can be stressful, and it’s very common for these administrative chores to be overlooked. But failure to update financial plans and legal documents can lead to unintended consequences later on, either when you die or if you become legally incapacitated and need someone else to make certain decisions on your behalf.

Got Questions?

These are just a handful of financial issues to consider at year end. Your financial and legal advisors can run through a more comprehensive checklist of planning options based on your personal circumstances. Call to schedule a meeting as soon as possible, before the hustle and bustle of the holiday season starts.

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