Tax savings, real or imagined?

Every year as we approach April 15, I receive a number of calls asking about contributing to an IRA or other Qualified Retirement plan, because of the “tax savings” offered by making such contributions.

And it is true that contributing to such a plan will reduce your tax liability in the year that you make the contribution.

However, to call it a “tax savings” may not really be accurate. Contributing to an IRA or a qualified retirement plan really does two things: it defers the tax, and it defers the calculation of the tax, to an unknown date and rate. I know the theory is that you will be in a lower tax bracket when you retire, but in my 40-plus years of being a financial advisor, I have learned that very often clients are actually in a higher tax bracket after they retire.

There are a few reasons for this; many of the deductions and exemptions you had during your working career are gone. Such as your now paid off mortgage interest and your no-longer-dependent children. Your tax bracket may have actually increased.

And many taxpayers have assumed that their Social Security income will be tax free, only to learn that due to withdrawals from their retirement plans, or other income they receive such as Muni Bond income, up to 85 percent of the SS income is taxable. Another “gotcha” from our friendly uncle!

And what if the IRS changes the thresholds as they have done many times in our history?  That is the single easiest method to increase tax revenues – simply redefine who is “rich.”  The most dramatic example of that is what happened in 1942. In 1941, the maximum tax bracket was 81 percent on all income above $5M.

In 1942 the rate was changed to 88 percent on all income above $200,000. Talk about a huge increase!  Then they followed that up with an increase in 1944 to 94 percent on all income over $200,000.  A similar change occurred in 1965, in 1982, and in 1987 also, although these were not as dramatic as 1942.

Will they do that again sometime? It’s anybody’s guess, but consider this: normally wars are paid for by tax increases, but we didn’t have increases following the Gulf war or Iraq.  We have all time high national debt, and a comparatively very low tax environment. It’s probably not going to get better any time soon.

The good news is there really are strategies that can reduce taxes. I’ll be glad to discuss tax strategies if you’d like, feel free to call or email.

I’ll be glad to discuss tax strategies if you’d like, feel free to send me an email ken@kendallfinancial.net, or call my office 972-874-8757.

Death & Taxes

The old expression that “nothing is certain except death and taxes” will take on a new meaning on Jan 1, 2011.

As you may know, the rules governing Federal Death taxes were changed back in 2001, and the current laws will expire at the end of this year. This year there is no Federal Estate Tax, so no matter how large an estate, people who die in 2010 will have no Federal Death taxes. However, effective Jan 1, 2011 the old rules come back, and any estate over $1 Million will be subject to Estate taxes, which can be as much as 55-60%. Most estate planning practitioners expected Congress to change the tax rules prior to Dec 31, 2009, but in their dedication to pass health care reform, they didn’t get around to addressing the Estate tax.

How will this affect you? If you die with as- sets over $1 Million, your estate may owe taxes. That may seem like a large estate, but consider the value of your home, your life insurance, your re- tirement plan balance, and it is easy to exceed $1 Million. The tax rates start at 18%, and quickly escalate. So if your taxable estate is over $2 Mil- lion, you will already be at the rate of 45%.
Under the rules in effect since 2001, many peo- ple have grown complacent regarding their estate plan. After all, in 2009, the amount you could pass tax free was $3.5 M. Now however, the pic- ture has changed dramatically.

What this means is that virtually everyone should review their estate plan, because there are several specific strategies that can be utilized to reduce or even eliminate the Federal Estate tax.
So where do you start?

1. The first step is to determine the size of your estate, which includes: your home, other real es- tate, jewelry, stocks, bonds, mutual funds, bank accounts, insurance, retirement plans, business interest, or any property over which you have a general power of appointment. Note how they are owned. Take a similar inventory of your debts and liabilities.

2. Determine your goals regarding your estate. For example, do you want any of your assets to go to charity?

3. Consider the tax ramifications of your plan.

4. Develop an organized plan for the payment of taxes and expenses. Without this plan, the most valuable assets you own may have to be sold to meet the tax bill.

I am offering a free estate analysis. Please call 972-874-8758 or email me ken@kendallfinancial. net to take advantage of this offer.