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Year-End Tax Planning Strategies
James Lange, CPA/AttorneySpecial Guest: Diane Markel, CPA/MBA
Please note: Some of the events referenced in our audio archives have already passed. Please check www.retiresecure.com for an updated event schedule.
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- Introduction of Special Guest: Diane Markel, CPA
- Roth IRA Conversion Strategies
- Year-End Deadlines for Deduction/Credits
- Tax Loss Harvesting
- Education Credits and Section 529 Plans
- Are Substantial Tax Increases on the Horizon?
- Recap of Year-End Tax Strategies
Beth Bershok: We are talking smart money. Thank you so much for joining us tonight. I’m Beth Bershok along with Jim Lange CPA, attorney, best selling author of two editions of Retire Secure Pay Taxes Later, and we have a special guest in the studio with us tonight. We’re doing year-end tax strategies, getting prepared for 2010, and we have Diane Markel with us who has been working with Jim. Diane, how long have you been working with Jim?
Diane Markel: It’s been eight years.
Beth Bershok: And Diane is a CPA and an MBA, and you specialize in individual taxes.
Diane Markel: Correct.
Beth Bershok: So, Diane is going to be helping us through some of these year-end tax strategies. It’s hard to believe it’s November, and it’s time to be thinking about that already, but I know that Jim wants to start with the hot, hot, hot topic for 2010 which is that there’s a tax law change coming up on January 1. Up until this point if you wanted to make a Roth IRA conversion there were income limits, but on January 1 the income limits go away at this point forever, and it’s going to make a huge difference, Jim, for a lot of families. So what should those people be thinking about now?
Jim Lange: Well, before we get to 2010, we have to finish out 2009.
Beth Bershok: Okay..
Jim Lange: Alright, now for most people who are never able to make a Roth IRA conversion because their income was over $100,000, 2010 is going to just be a banner year, and it’s going to be a tremendous opportunity. I actually believe that virtually every IRA and retirement plan owner should have a long term Roth IRA conversion plan. So the plan might be to convert a number of smaller conversions over every year, say for five years or ten years or perhaps one large one or perhaps a big one and a small one depending on his/her situation and tax brackets. Before we get to 2010, we have to talk about 2009 because 2009 is an unprecedented opportunity for many seniors. Many seniors do not have to take, or all seniors do not have to take, a minimum required distribution this year, and the reason that is so significant is because for a lot of people who are aged 70 and older– and in the past and in the future they’re going to have to take minimum required distributions and now this year they don’t– the opportunity of a life time for them is making a Roth IRA conversion at a low tax rate. So what most seniors are doing is saying, thank you Uncle Sam, I heard about that I don’t have to take a minimum required distribution. I like the idea of not paying taxes now, letting the money accumulate and then next year and in future years when I have to take a minimum required distribution, I will do so. And what I would like to say to those listeners is wait, this is an opportunity. You’re going to be in the lowest tax bracket that you’ll ever be in the rest of your life even if they don’t raise taxes, which I think they will, just the fact that you don’t have your minimum required distribution means that your taxes will be lower than ever. Meaning your tax bracket will also be lower than ever meaning that this might be the best year to make a Roth IRA conversion.
Beth Bershok: Now we’re going to be getting to something in just a minute, Jim, because if you did take that minimum required distribution in 2009, there’s a special break and we’re going to be talking about that in just a minute, but let me toss this question out. Is there any talk of extending that into 2010, has there been any talk at all or will it end on December 31?
Jim Lange: As far as we know right now it will end on December 31. Whether that will be extended will be anybody’s guess, I wouldn’t even want to say what the chances of that are. I think right now for our purposes we have to assume that it will come back and how to best plan accordingly.
Beth Bershok: So we move on to January 1, 2010 which is when the income limits are off, and Jim is going to be celebrating, I think, on that day all day long. He’s been waiting for this day.
Jim Lange: Literally for ten years salivating.
Beth Bershok: Now I know that you’ve been strategizing with the clients who come through the office for this, but if you’re just hearing about this and you suddenly realize that income limits are off for Roth IRA conversions in 2010, what should you be doing now for the next couple of months to get ready for that?
Jim Lange: Well, one of the strategies that I like is often a series of Roth IRA conversions. And the other thing that I sometimes like is to make perhaps different Roth IRA conversions and perhaps reserve the option of undoing or re-characterizing your Roth IRA conversion. One of the things that you can do to prepare for possible Roth IRA conversions and possible reconversions or re-characterization if the underlying investment goes down is to separate your IRA into several different accounts. I have some people who are separating it into ten or twenty different accounts and the idea is that you can make multiple Roth IRA conversions and then for the ones that do well you keep, and the ones that don’t do well you re-characterize or undo them.
Beth Bershok: So at this point that’s one of the strategies you could do is separate your account?
Jim Lange: Yes.
Beth Bershok: Okay. Now at your office you do a lot of analysis in advance. What kind of thing happens in that analysis because there’s a guy on the staff, Steve, this is just his thing. He’s been doing Roth analysis for clients forever, and he gets really in depth. What are you trying to determine when that analysis is going on?
Jim Lange: For a lot of taxpayers, I’ll see somebody’s list of assets and tax return and will know right off the top of my head that they are a fabulous candidate for a Roth IRA conversion. But what I don’t know off the top of my head is how much they should convert and when they should convert. And I know there’s a lot of software out there, none of which I’m terribly thrilled at. There is no software that I know of that you can just put in a bunch of variables, say optimize and it tells you how much and when. The real way to do that is, it really comes down to what we call running the numbers. And that’s just doing different projections. So let’s say, for example, you start with the two extremes…what if you do no Roth IRA conversion and what if you do the whole thing? And then based on the tax bracket, what’s going on with people, how much money there is etc. Steve or I will come up with different possibilities. Well, what if we convert $50,000 a year for the next five years, what if we convert $200,000 now and then nothing for two or three years? What if we convert the whole thing, but if the asset goes down at all to re-characterize certain accounts. So we literally make projections into the future, and based on those projections, we will recommend a typically long-term course of action for a client.
Beth Bershok: So I want to toss out the office number, too, which is 412-521-2732. If this is something you’re starting to think about, and you think you need really to have an analysis like this, 412-521-2732. The office is in Squirrel Hill. One thing I do want to point out before we move on from Roth IRAs, Roth IRA conversions, is that this tax law change which is happening in January 1,, a lot of people seem to be confused on the length of time. Currently, that’s a permanent change.
Jim Lange: Yes it is. Now the way I think about it is the government is going to wake up one day and say, oh my God, what did we do because the numbers on it are so compelling. Without going into all the assumptions which would just bore people to tears, but if you make $100,000 conversion twenty years from now you’ll be $40,000 better off. If you then die and leave the Roth to your kids, they will be $800,000 better off. If you decide to skip your kids and leave it to your grandkids, they’ll be $8.6 million better off. So the numbers are compelling, and it really is a zero-sum game meaning if they are that much better off, that’s how much worse off the IRS is. I am afraid one day the IRS is going to wake up and say, hey we’ve been too generous, but what I’m confident is that those of us who have made conversions before they make any changes on the tax law will be grandfathered.
Beth Bershok: And there’ll be a space of time when we would know that would be coming.
Jim Lange: Yeah, I don’t think they’re just going to say surprise can’t do it.
Beth Bershok: Wake up one Monday, sorry you can’t do it anymore. So we’ll know, but in the meantime you should be planning this as part of your overall strategy.
Jim Lange: Yeah, I really think that everybody should at least be thinking about it. Now, it’s not going to be appropriate for everybody. For example if you’re in a high income bracket now and you’re going to be in a low income bracket later, it doesn’t make sense to do a Roth IRA conversion now. It might make more sense to wait until you perhaps are retired or you’ll be at a lower bracket. But for most people the beginnings of a Roth IRA conversion strategy is going to be very profitable for themselves and their family.
Beth Bershok: And a few minutes ago we were talking about the suspension in 2009 of the minimum required distribution for seniors. I want to back track on this for a second because there’s something new that just happened, and we haven’t had a chance to talk about this yet on the Lange Money Hour, and a lot of people missed this whole opportunity. The reason they missed it, I think< was because it didn’t really come down until the end of 2008. So some people were not prepared, they weren’t paying attention, they took their distributions anyway. But now you have an opportunity to what would we call it, roll the money back?
Jim Lange: I would like to call it put the toothpaste back in the tube.
Beth Bershok: Which usually isn’t easy to do.
Jim Lange: Because before, once the minimum required distribution or any distribution from an IRA came out, it was out and you couldn’t get it back in.
Beth Bershok: Ever.
Jim Lange: Right. So there was a 60-day rule on a distribution but not for a minimum required distribution. So now, since you don’t have to if people already have, there’s a new law that will allow people to actually put it back, and that’s a great opportunity if somebody doesn’t need to spend the money because A) it will reduce your taxes and B) what I’m advocating now is it will lower your income to potentially do a Roth IRA conversion in 2009.
Beth Bershok: Although you would have to do this quickly because we do have a deadline coming up.
Jim Lange: Yeah, you have to get it in by November 30.
Beth Bershok: November 30, so that’s just a few weeks away. So if you want to strategize about that, you need to think about rolling it back and possibly doing a Roth IRA conversion. So again, you have that opportunity but the deadline is November 30. We also have a lot of deadlines coming up, and I want to bring Diane Marco in on this one. Diane, who has been working with Jim for eight years, is a CPA, an MBA, doing a lot of individual tax returns.
Jim Lange: And one heck of a great tax preparer and a very kind person, and I really mean that sincerely. She’s done a fabulous job for us for eight years, and her clients just speak so highly of her.
Beth Bershok: Wow, seriously accolades, Diane, before we get to the question.
Jim Lange: It’s quite sincere.
Diane Markel: Alright, well thank you very much.
Beth Bershok: Diane, we need to talk about some of the deadlines coming up because this seems to be the type of year, tax breaks are running out, and this is why we’re talking about year end tax planning, but for instance there’s a new car, truck, motorcycle, motor home deductible, but again there’s a deadline approaching on January 1 so tell us how that works.
Diane Markel: Okay, well this only applies to new vehicles.
Beth Bershok: New vehicles, so if you’ve got a used vehicle, not applicable.
Diane Markel: Correct, and you have to have purchased it by February 16 of this current year, and this was a way for the government to try and help move the cars because it was such a slow economy. So you are going to be able to deduct the sales tax on the new vehicle whether you itemize or you don’t itemize.
Beth Bershok: Now again that deadline is–well the vehicle has to be purchased before January 1?
Diane Markel: Correct.
Beth Bershok: So if you have in your mind, gee, I really need a new vehicle, this may be the next couple of months you want to think about that because after January 1 that deduction is over.
Diane Markel: There is an upper limit on that also. It’s a car that costs up to around $49,000.
Beth Bershok: Okay. Is there an income limit, there is a limit on your income on that, is there?
Diane Markel: I’m not sure. Yes I believe there is. I believe there is a phase out on that so for the upper limits, you might be restricted on taking that sales tax reduction.
Jim Lange: On the other hand, if you’re talking at least a $20,000 car, you’re talking about a $1400 deduction. That’s not inconsiderable.
Beth Bershok: No. Exactly . So we also have the new home buyer credit, and it was along the same lines, Diane, where they were trying to really jump start moving homes with the economic situation, but this is about to expire.
Diane Markel: Yes, it is.
Beth Bershok: So, what do you think? Do you think you can possibly even get in on this right now because the deadline is the end of the month.
Diane Markel: Unfortunately, I don’t think so because you have to close on the house by the end of the month.
Beth Bershok: So you can’t just have an offer on it, this has to be closed?
Diane Markel: Correct.
Beth Bershok: Well if you were really, really fast, if this weekend you ran out and you looked for a house and put an offer in on it, but you know I have heard talk about extending that deadline.
Diane Markel: Possibly, I’ve heard the same talk but right now there’s nothing definite. Currently you can get a 10% tax credit. This only affects people who have not owned a house for the last three years. So there is some qualification there. And you can take a credit of 10% up to the value of the house of $80,000, so that effectively means almost an $8000 credit, and that counts whether you owe taxes or don’t owe taxes. You would get that money back either way. It’s a great deal.
Beth Bershok: It is a great deal. But we don’t know if it’s going to be extended yet, so currently the deadline is the end of the month.
Diane Markel: Correct.
Jim Lange: One note I’d like to interject, and it’s not really a tax issue, but it is, I think, very germane to a lot of our clients. I hear a lot of talk about the risk of inflation and pressure on the interest rates and the interest rates on mortgages and fixed obligations going up. Sometimes people say, well what did I personally do with that? Well, I’ll tell you what I did, I actually remortgaged because right now there are some pretty favorable remortgage rates. I was able to refinance my house at 4.625%. It might be a little bit higher today but I’ll just say in the area of housing, if you’re thinking about what you can be doing now to be thinking long term taxes saving money. If you can fix a rate at a fairly reasonable rate–even a conventional 15-year mortgage and lose some of the risk of the variable rates–I think that might be something that people should consider.
Beth Bershok: So even if this home buyer credit is gone, I mean that’s something you should just be thinking about.
Jim Lange: Yeah, I mean the home buyer’s credit is great, but it’s just on the subject of housing. Probably most listeners here have already owned their home, and maybe even had it paid for, but I will say that this is probably one of the best opportunities that I see coming in the next many years for getting very favorable rates.
Beth Bershok: Well, what do you think about the interest rates? I mean, do you think they’re going to zoom up one day out of the blue or do you think it’s going to be a creep up?
Jim Lange: I think it’s going to be a creep up, but the problem is it’s hard to know when to move on or you know when to jump on, and I think one of the natural tendencies is just kind of wait and see, and then before you know it it’s much higher. And remember even 1% makes a tremendous difference in your long term payments.
Beth Bershok: Oh, it does. Diane I also wanted to address the energy incentives because of the American Recovery and Reinvestment Act of 2009. That amount has changed.
Diane Markel: Yes, this is becoming more generous now in 2009. You used to only get a 10% tax credit on some energy efficient property and that has been increased to 30%. Prior to the new law, there was a maximum of $500 on the credit and that has been increased to $1500.
Beth Bershok: What kind of things are we talking about?
Diane Markel: Energy efficient furnaces, hot water tanks, insulation, exterior windows. It really is a great opportunity to upgrade your home right now.
Beth Bershok: And this continues through 2010?
Diane Markel: It does, and it was not in the law for 2008 which was very confusing to many tax payers.
Beth Bershok: So 2009 and 2010. Well, maybe something you did in 2009, and you weren’t even aware that there was a bump in that credit. So you should just be aware that the bump went from 10% to 30%.
Diane Markel: Yes.
Beth Bershok: Alright, that’s the energy incentive and that 30% continues into 2010.
Diane Markel: Correct.
Beth Bershok: Alright we’re going to take a quick break, we’re talking about year-end tax strategies. Jim Lange, Diane Marco we will be back in just a minute it’s the Lange Money Hour Where Smart Money Talks.
Beth Bershok: Thank you for joining us tonight, and we are talking more smart money. We are doing year-end tax strategies for 2009 and getting prepared for 2010. I’m Beth Bershok along with Jim Lange and Diane Marco, who has been working with Jim for the past eight years. She is a CPA, MBA, and we were just talking before the break about energy incentives and Diane, you had mentioned that the credit now has increased from 10% to 30% and that is continuing through 2010. But Jim you wanted to add something about the whole energy incentive– how to look at it in the big picture.
Jim Lange: Well, in the big picture, if you don’t believe the literature, many of these improvements will actually pay for themselves. So, for example, an energy efficient furnace over time in terms of the reduced heating bills in your future will pay for itself. I’ve heard a different number of years depending on the product, the price, the size of your home etc. So, if you are going to ultimately have something that is going to help you in the long run, and you get a 30% credit on top of that, you could literally come out cash ahead and end up with either better window insulation or a better furnace or whatever the energy saving might be. But what I wanted to tell people is you have to check with the contractor or the manufacturer to make sure that it is certified to qualify for the credit, because let’s just say you get some energy efficient windows, and you get them put in, you put all this money in and then you want to take a credit and find out that particular brand was not certified. Now you’re thinking that’s going to cost me 30% more than I thought it was. So you want to make sure ahead of time, before you invest the money, It should be part of your shopping decision whether a particular set of windows or furnace, etc. is certified for the credit.
Beth Berhsock: And then what do you need if you’re going to try to take this deduction or take this credit? Ddo you need an actual certificate saying that this is energy efficient, it qualifies for this?
Diane Markel: Technically, that’s what the IRS would like to see, documentation that it does qualify. You can also go onto the IRS website. They have some information on the website as to what qualifies. For example, all Energy Star windows supposedly qualify. So because this credit is 30% now versus 10%.
Beth Bershok: You think they’ll be a little pickier?
Diane Markel: They are. It’s more stringent.
Beth Bershok: Okay, so you want to make sure that that qualifies because that would be a shock. You think you’re about to get 30% and then find out you’re getting nothing.
Diane Markel: Right, but I would think it would be a selling point when you go to purchase these supplies. I would use it as a selling point if I were a sales person.
Beth Bershok: Sure, especially because this is continuing through 2010. So just make sure in advance you do your homework a little bit and make sure you buy something that qualifies.
Diane Markel: If you choose to do that.
Beth Bershok: If you choose that. Okay, I also want to talk about bonus depreciation, and Diane, I’m going to go to you just to explain it. This is the 2009 American Recovery and Reinvestment Act. It extends the additional first year depreciation deduction of 50% of the cost of assets purchased through December 31, 2009. That’s a big long complex sentence so can you first break that down and explain exactly what that means?
Diane Markel: In the past, the one depreciation deduction that most of us are familiar with is called Section 179, and that is depreciation where you can write off an asset in the first year without depreciating it over many years.
Beth Bershok: Completely write it off.
Diane Markel: Correct yes. To be eligible for the section 179 deduction you have to have income to be able to deduct that but the bonus depreciation is a little different. You can write off an additional 50% of depreciation without having the related income from the business. So you can create a loss by writing off the…
Beth Bershok: Oh, that could be a serious tax credit tool.
Diane Markel: Correct.
Beth Bershok: But that is only going on through December 31,, purchased through December 31.
Diane Markel: Yes, as far as I know right now.
Beth Bershok: Yes, as far as you know and that is a change, that extra 50% is a change?
Diane Markel: Actually we’ve had that in the past.
Beth Bershok: Oh, okay.
Jim Lange: What’s new is we can actually create a loss, and I’ll tell you why this is going to be relevant for a lot of listeners. I think a lot of people–particularly people who are either unemployed or under employed– and they are starting businesses and trying to figure out a way to eke out a living. They have some start up expenses, they’re buying computers and they’re buying disks and they’re getting set up, and maybe right now, they don’t have income and now they’re allowed to in effect expand what they used to have to depreciate over five years and they can actually claim a loss and then use these losses to offset other income on their return or they can use the losses to lower their income for Roth IRA conversion.
Beth Bershok: Everything always comes back to that Roth IRA conversion.
Jim Lange: A lot of it does, but actually this is a very good opportunity. And a lot of times people who are in the early stages of setting up these businesses don’t bother taking these deductions until they have income coming in, and that’s not necessary.
Beth Bershok: For this year?
Jim Lange: Well for all years. To me, if you have a legitimate business loss you should take it. What’s unique this year is that you can actually take a loss due to the bonus depreciation.
Beth Bershok: Okay, we’re talking all about tax planning for year end on The Lange Money Hour Where Smart Money Talks. And Jim, for a minute I just want to touch on–we’re only going to be able to skim the surface on this one–his idea is kind of complex, and we actually once did an entire show on tax loss harvesting. So if you can just explain what it is and why you should be looking at this for the next couple of months.
Jim Lange: Well, what it basically is is the offsetting of capital gains and losses on your tax return. So, let’s say you have some stocks that can be sold for a loss, and let’s say, there’s some that can be sold for a gain. Well, the smart thing to do this year is to sell the winners and now you have a capital gain. And if you do nothing other than that, you’re going to have to pay capital gains tax. Well what might be prudent is to say I’m also going to take some of my losses, and that way I’m going to offset my gains and losses. Now that’s just the very simple part. Then, of course, many of us have more losses this year, so it might make sense to actually recognize those losses, deduct up to $3000 in capital losses and potentially even recognize them and get a capital loss carry forward. By making a sale recognizing the loss, we are actually creating a situation where we can have gains in the future that will be offset.
Beth Bershok: So that’s the simple explanation. I am going to—
Jim Lange: Sorry about that… there’s so much that can be done with this, and it is routinely not done, and it routinely should be done.
Beth Bershok: I actually want to guide people to our website for a second, because we did an entire hour on this topic and. We talked to Bob Keebler about this, and he really had some in-depth explanations of how you should look at this. So if you go to www.retiresecure.com and you see The Lange Money Hour it lets you click on a link that has all of the audio. It really probably would be helpful to listen to that whole show. It’s the Bob Keebler show, and you can get a really good explanation on how this works. But it is definitely something that people should be looking at in the next month or so. Alright now, education expenses is something else that people should be looking at, Diane, at the end here of 2009. What exactly should they be taking a close look at when we’re talking about education expenses?
Diane Markel: Okay, well the good news is the credits are more generous in 2009 with the very high cost of college. I know this because I have two children in college.
Beth Bershok: And it keeps going up.
Diane Markel: Yes, so this was well deserved. For at least the current tax year, 2009 and 2010 for all four years of undergraduate school, you can take up to $2500 of a tax credit. A credit is much more valuable than a deduction. So essentially if a student has $4000 in a one calendar year–
Beth Bershok: And who doesn’t?
Diane Markel: And who doesn’t is correct. Then they can take $2500 of a tax credit.
Beth Bershok: Who is this, the student?
Diane Markel: Actually, no. Actually it’s on the parent’s tax return.
Beth Bershok: It’s on the parent’s tax return, okay.
Jim Lange: Does it have to be a dependant? Well, I’m getting a blank stare.
Diane Markel: I believe it does.
Jim Lange: Alright, and the other question is I believe a grandparent cannot take the credit unfortunately. That’s one of my favorite ways to pay for tuition, to have grandma and grandpa pay it directly because when grandma and grandpa pay tuition directly, it is not deemed a gift. So if grandma and grandpa are interested in helping their grandchildren, they can actually make gifts and on top of that pay for tuition and pay medical bills. We’ll get to 529 plans later, but I think there are some wonderful things the grandparents can do regarding their grandchildren’s education.
Beth Bershok: Yeah, we’re going to be getting to that in just a minute. But I did want to point out to you with this education expense issue, up until now required course materials like books were not eligible for this, but this is now included.
Diane Markel: Yes, and that was very much a stickler point in the past. In the past you could add this to the whole credit if the books had to be purchased at the book store, and my tax clients and I had gone round and round on this many times. Now the required course materials are also included as part of the cost to be able to obtain the credit. And the other really great news is if, for example, your total tax liability is $1000 , technically you can’t use the full $2500 credit. For 2009 and 2010, you can actually get part of that credit back, money in your pocket like up to 40%. Isn’t that amazing?
Jim Lange: Reverse taxation I love it. It’s like the earned income credit. You don’t pay anything going in, you get a lot more going out. I like it.
Diane Markel: Yes, for all the parents out there paying huge college bills as I am, we need to really pay attention to this.
Beth Bershok: Okay, Section 529 and Jim, you just mentioned that a moment ago, are there changes that happened in 2009, 2010?
Jim Lange:There are changes. First, let’s talk about the basics with Section 529 plans. 529 plans are a variation of a gift. I’ve always been a believer in three types of gifts that grandparents can give their family. One is what I call as needed gifts to their kids. Their kids need some money, whether it be for a car or a down payment or just to make ends meet, straight forward gifts, and I’m a big believer in that. The second type of gift I’m a big believer in is Section 529 plans. Section 529 plans are basically money that has been put aside for grandchildren. The way it works is you make a contribution, you pick a state and for most purposes, it doesn’t really matter that much for federal taxes which date you pick but let’s say that you pick Utah because Vanguard happens to be the investment arm in Utah. So you pick Utah and you pick the set of funds that Vanguard offers in Utah and let’s say you put in $5,000 or $10,000 or whatever you think might be appropriate for your grandchild, and then what happens is that money grows income tax free. Then when the grandchild is old enough to take the money out or is ready for college, then they come to you and say, hey guess what grandma and grandpa? Good news, I got into Berkley in the computer science division, the tuition is only $300,000. Now I understand that you have put away a couple dollars for me to pay for the tuition. Then if you think that is appropriate for the child and it’s okay with you, then you say okay, and you release the money. Now let’s say instead the kid comes to you and says, hey guess what? I decided to go to the University of the Sun Devil Worshipper, and we climb the mountain and meditate, and everything is going to be great.
Beth Bershok: Grandma’s not too happy right now.
Jim Lange: And you say, you know something, that’s not really what I had in mind for tuition, and the answer is no. The other thing you can do with it is you can switch it around not only among grandchildren from the same child but actually among first cousins. So let’s say somebody didn’t go to school or one person’s school was more expensive or one person has a scholarship or whatever it might be, you can shift it around, so that’s a nice feature.
Beth Bershok: So with these 529 plans you don’t have to name the beneficiary? You don’t have to say this is definitely going to Diane’s son. You just establish this fund?
Jim Lange: No, you must establish who it is intended for, but you’re allowed to swap. So let’s say that you have two children, and each of your two children has two children. So there are four potential kids that are going to go to college. Let’s just say that you fund them all equally. One kid gets a scholarship and doesn’t need any money, and another kid really needs everything. Let’s say one kid doesn’t go to college at all and then somebody else needs some money. You can shift from one first cousin or sibling to another and that adds great flexibility for the grandparents.
Beth Bershok: And what if nobody goes to college?
Jim Lange: Well, then you can do one of two things. 1) You can withdraw the money and pay a 10% penalty on the earnings. By the way, I’ve actually done calculations. If you have the money invested for 24 years, the penalty is actually a break even situation.
Beth Bershok: Yeah, it doesn’t sound so bad.
Jim Lange: No, it’s not so horrible. Or 2) You can just let the money sit there and use it for the next generation.
Beth Bershok: Let’s get back to the state issue for a second. You said pick a state. What is the purpose of that?
Jim Lange: You have to pick an investment. You can’t just go to Vanguard and say, hey I want a 529 plan. Every state is going to have one. I think all the states have one, maybe Louisiana doesn’t.
Beth Bershok: You know, Jim, people are listening online, and they are listening in Louisiana as we speak.
Jim Lange: There are one or two states that might not have them but I think most states do, and the states will pick a vendor to offer the investment choices. So there are a few tax breaks if you pick the state that you happen to live in. I know Pennsylvania I’m much happier with the provider now than I was in the past. But most states will pick this vendor, and it doesn’t really matter where the child is going to school or what resident state that the child resides in.
Beth Bershok: Is there a limit on contributions for 529 plans?
Jim Lange: Yeah, it’s the regular limit which is $13,000 per year without getting into your once in a lifetime exclusion. If you are joined by your spouse, it can be $26,000 per year per beneficiary. Then there’s a special rule that you can do five years gifting at once. So you could actually give $130,000. So the limitation is going to be on what you think is appropriate, and I go back to the three-prong gifting approach. I like three gifts, I like 529 plans, I like as needed, and I like second to die life insurance.
Beth Bershok: I know we keep saying grandparents, but anyone can establish this plan.
Jim Lange: Sure, you know parents are very likely. That’s probably the best way to save for college for parents. I happen to look it for grandparents.
Beth Bershok: Maybe that’s because he has a daughter who’s probably going to be going to college.
Jim Lange: I can’t say that’s not a factor, but it’s also I found that many of my clients are grandparents, and they have a certain work ethic and desire to see value for their money, and they want to see their money going towards certain things. Most of them don’t want to see their money going to finance a Ferrari for their grandkids.
Beth Bershok: Usually not.
Jim Lange: Yeah, you know, they’ve worked hard for the money, and education is something that many of them actually value and prize, and then the idea of being able to do it from a tax efficient manner is even that much more attractive.
Beth Bershok: Now, while we’re talking about year-end tax planning, I want to point out there is still time to set up a 401(k).
Jim Lange: I love 401(k)s for self-employed people and even for employees I greatly encourage people to take advantage of 401(k)s. At the risk of sounding like a broken record, the 401(k)s –the newer ones–have a Roth component in them. For example we’re a relatively small firm of ten people, and we have a 401(k) plan. Our employees get a choice for their contribution to go into a traditional 401(k) or a Roth 401(k) which has all the advantages of tax-free growth.
Beth Bershok: And if you don’t have a plan established, you have until December 31 to establish that plan, and do you have to fund it by then as well?
Jim Lange: No, you can fund it I believe by April 15.
Diane Markel: Well, the employee deferral portion has to go in there by December 31, but the employer part can go in after the first of the year.
Beth Bershok: Alright, we will be back with some more year-end tax planning tips and getting prepared for 2010. It is The Lange Money Hour Where Smart Money Talks.
Beth Bershok: Talking smart money and getting ready for year end. We are doing some year-end tax planning here. I’m Beth Bershok along with Jim Lange and Diane Marco who has been working with Jim for the past eight years, CPA and MBA. We’ve been covering a lot of issues, so many things to think about here as we’re getting ready for 2010. Something that a lot of people have been talking about Jim, if you could address this. We’re in these turbulent economic times, and even though technically people say the recession is over, the recovery is going to be long, and one of the big question marks out there is tax rates and what is going to happen, and the idea that tax rates may increase dramatically. First of all, do you think that’s going to happen, and what can you do about it?
Jim Lange: Well, first there’s already legislation that is going to happen that’s going to increase tax rates. The tax cuts that President Bush implemented are going to expire after 2010. So we know that even without additional action, taxes are going to go up in 2011. The other thing, you know, realistically we are at interestingly enough a historic low in terms of tax rates.
Beth Bershok: Every time you say that, I find that so hard to believe.
Diane Markel: Oh no, that’s true.
Beth Bershok: I know every CPA on the planet is saying that, but it just seems when you look at your checks that a whole big hunk of money coming out.
Jim Lange: But I think it’s going to get a lot worse, I really do, I fear substantial increases, particularly in the upper income brackets. So you know sometimes the traditional thinking of deferring income as long as you can maybe should be challenged. I’ll give you an example. In 2010 you’re going to be able to make a Roth IRA conversion, and you’re going to have the option of recognizing that income either in 2010 or half in 2011 and half in 2012. Well, naturally CPAs love to defer paying taxes. The title of my book says Pay Taxes Later. But particularly for our upper income tax clients who are already in the 35% bracket, I’m going to be very tempted to recognize the income in 2010 and the reason is because for 2010 at least as far as we know now 35% is going to be the top tax bracket. If you defer it until 2011 and 2012, you might have a 40-50% tax bracket. And by the way, I remember when taxes were 50%, and it wasn’t that long ago that it was 70%. So I think the idea of being aware of future tax rate increases is going to be important particularly in the Roth IRA conversion world. That’s an immediate example, and I think some of our savvier clients are saying well, maybe as much as I like deferring it, I like paying less tax even more.
Beth Bershok: Because what you’re saying is if you’re at the top bracket and you do a Roth conversion you pay 35%. Years down the road that might be 70%. So in the meantime you’ve only paid 35% and it has been growing tax free.
Jim Lange: That’s right. Earlier when I said that you’d be $40,000 better off and your kids would be $700,000 and your grandkids $8.6 million, that doesn’t include the potential for tax increases. So if tax rates go up, then the benefits of Roth IRA conversions are that much greater.
Beth Bershok: This may seem like an insane question, can either one of you see an opportunity or a time where that would not happen, where tax rates may actually drop?
Jim Lange: I would for individuals. Not for everybody, but people can actually plan low tax years. So, for example, 2009 is a low tax year for seniors because they don’t have their minimum required distribution. If you are working, and let’s say you’re at the top of your game making a good salary and are not yet 70 ½, and you plan to retire next year or two years from now. Those years are going to be much lower tax years for you, even if the tax rates in general are up. So I think there are two things to consider,1) the general tax environment and 2) perhaps more importantly what is going to be your tax rate, and if you have some idea of what your tax rate is, what should you do about it.
Beth Bershok: Any other strategies that you would advise or consider with that in mind that the tax rates may go up dramatically?
Jim Lange: Well, I think one thing is that normally we always say defer income, defer income and accelerate expenses. Maybe that’s not going to be true for everybody, but what I don’t want people to do is to try to generalize and say tax rates are going up for everybody, therefore I have to reverse what I normally do. I think you have to get some grasp of where you are and where you will be in the future.
Beth Bershok: You know, Diane and Jim, we have covered a lot of ground. We’ve covered so many things getting ready for year end and for 2010. Can we do sort of a quick check list? If you were just an average client and you were coming into see one of you, two things that you know, just a quick checklist to kind of recap what people should be looking at here before year end.
Jim Lange: I always go to the big issues like are they contributing the maximum to their retirement plan, are they doing a Roth IRA conversion, should they prepare for Roth IRA conversion by separating accounts? Should they be coming up with a long-term Roth IRA conversion plan and actually a tax plan in general? I think that’s the big picture. Are they maxing out their 401(k), have they taken advantage of the Roth 401(k), or for our university and hospital friends our Roth 403(b), and then all the other things that we had mentioned today like some of the energy credits and some of the home buying credits and the tax deductions for the cars. I think all those are very great money saving opportunities.
Beth Bershok: It’s a lot to think about. I will say that this audio will be posted on www.retiresecure.com, and we also have a link on our websites to some more information concerning all of these issues, so I would definitely take a look at all that. And Diane, I want to thank you so much for joining us today. Diane was a great guest, and we do have coming up a November workshop, the last workshop for 2009 where we talk about Roth IRAs, Roth IRA conversions for 2010 and the RMD suspension for 2009 for seniors.
Jim Lange: This has been the most successful workshop I’ve ever had in over ten years of doing workshops. You know, we’re just getting huge results, and people are acting on it which is really nice. They’re coming in to see me afterwards, and we’re actually doing things that are going to save people a lot of money.
Beth Bershok: Well, there is one more opportunity to do that so I want to give the RSVP and explain what’s going on. This is going to be on Saturday November 21, and it’s going to be at the Four Points by Sheridan in Mars. Actually, we had a great turn out when we were there a little earlier this year. So these workshops are free. There’s one from 9:30 to 11:30 in the morning and there’s also one from 1:00 to 3:00 in the afternoon. Now the key is you have to RSVP because especially since this is going to be the last one for 2009 I have a feeling these are really going to fill up. These have been filling to capacity. So if you’d like to attend this workshop, it’s 800-748-1571 and Jim, if you could kind of just quickly give an overview on some of the things that you cover. You also cover your estate plan.
Jim Lange: I do. I think for a lot of people who are naturally reluctant to go to workshops you should understand that there’s going to be some major education here with Roth IRAs and Roth IRA conversions. It is basically the same workshop that I get paid $10,000 a day to give out of town. And people say oh, don’t you give them much more sophisticated and a much tougher one for advisors? No, I really provide some real meat. So we go into understanding the basics of IRAs and Roth IRAs and Roth IRA conversions, and then we take a look at the math behind it. Then we try to see which people are good candidates and which are not. And that takes probably an hour and even close to an hour and a half of solid material. We also cover what is for most IRA and retirement plan owners the best estate plan on the planet, I believe.
Beth Bershok: Touch on that one quick second.
Jim Lange: Well, that’s the one that has been literally all over the press, Jane Bryant Quinn, Kiplinger’s, New York Times, Wall Street Journal, Financial Planning, all over the place, and it is a very flexible estate plan that defers or puts off all the tough decisions until after a death. So if you have a traditional marriage where you trust your husband or you trust your wife, there is a much better model for estate planning than the one that you probably have right now.
Beth Bershok: And it honestly works hand in hand with all of the other information you give in the workshop.
Jim Lange: And then the combination of Roth IRA conversions and this flexible estate planning, it’s a whole lot money for you and a whole lot more money for your family.
Beth Bershok: Notice how he phrases that as a whole lot more money for you a whole lot more money for your family. Actually, it’s great information so again the next workshop–and it is the final one for 2009 so if you’re really interested in Roth IRA conversions and the tax law change that’s coming up on January 1, I strongly recommend that you attend the workshop— Saturday November 21 at the Four Points by Sheridan in Mars, and it’s 800-748-1571. Again, space is limited so you should RSVP. Two other quick things that I want to mention about the workshop. At the end of the workshop, Jim offers free consultations (for PA residents only) with him, but that’s if you’re at the workshop, and then you sign up at the workshop. And also everybody that attends gets a free copy of Jim’s book Retire Secure! Pay Taxes Later, the second edition. So you get the book, you can read all of the information that Jim has been covering and again the workshop is Saturday November 21, it’s 800-748-1571, and you can also get all of the information and how to RSVP on the website which is www.retiresecure.com. Thanks again to Diane Marco for joining us today here on tax planning. Next show is coming up on Wednesday November 18. This is an interesting twist. We are going to have Pittsburgh City Controller Michael Lamb, and he’s going to be talking a lot about city finances and how that’s handled and that’s coming up on November 18. It is the Lange Money Hour, thank you for joining us. The Lange Money Hour Where Smart Money Talks.
James Lange, CPA
Jim is a nationally-recognized tax, retirement and estate planning CPA with a thriving registered investment advisory practice in Pittsburgh, Pennsylvania. He is the President and Founder of The Roth IRA Institute™ and the bestselling author of Retire Secure! Pay Taxes Later (first and second editions) and The Roth Revolution: Pay Taxes Once and Never Again. He offers well-researched, time-tested recommendations focusing on the unique needs of individuals with appreciable assets in their IRAs and 401(k) plans. His plans include tax-savvy advice, and intricate beneficiary designations for IRAs and other retirement plans. Jim’s advice and recommendations have received national attention from syndicated columnist Jane Bryant Quinn, his recommendations frequently appear in The Wall Street Journal, and his articles have been published in Financial Planning, Kiplinger’s Retirement Reports and The Tax Adviser (AICPA). Both of Jim’s books have been acclaimed by over 60 industry experts including Charles Schwab, Roger Ibbotson, Natalie Choate, Ed Slott, and Bob Keebler.