If you’re not familiar with charitable IRA donations, for the past few years taxpayers age 70 ½ or older have been able to make direct transfers of up to $100,000 per year from their IRA to a charity.  By giving the money directly to charity (rather than receiving the distribution then later cutting a check to your favorite charity), taxpayers were able to exclude the IRA distribution from their income.

This was a great strategy for IRA owners who didn’t need the money from the required minimum distribution as they won’t have to pay a large tax bill for IRA withdrawals that they wouldn’t otherwise have taken (if not required to by the RMD rules).

The direct transfer strategy not only reduced their taxable income, but it also reduced their adjusted gross income, which resulted in many taxpayers having less of their Social Security income taxed; it also allowed taxpayers to qualify for credits and deductions that they would not have qualified for otherwise because their income was too high.

This IRA donation strategy was introduced in the Pension Protection Act of 2006 and was originally only intended to apply to the 2007 tax year.  It was later extended to include 2008 and 2009.  IRA owners who have taken advantage of this strategy were hoping that it would be extended for 2010, but for a while it didn’t look like it would happen.  Thankfully, Congress included a provision in the tax bill passed last week to extend the ability to donate IRAs directly to charity for not only 2010, but 2011 as well.

Since this bill was passed so late in the year, you may have already taken your 2010 RMD and written a check to your favorite charity.  You can still deduct your donation on Schedule A: Itemized Deductions (if you itemize your deductions).  However, please note that you can’t do both.  If you do a direct transfer to a charity from your IRA you will exclude the distribution from your income; if you write a check to a charity you will deduct it on Schedule A.

Thanks to Kay Bell at Bankrate.com for the update on RMD charitable donations in “How the New Tax Law Affects Your 2010 Taxes”.

Kristine McKinley is a fee-only financial planner located in Lee’s Summit, Missouri.  Kristine provides retirement planning, tax preparation and planning, investment reviews and comprehensive financial planning on a fee-only, as needed basis.  To schedule your complimentary introduction meeting, please contact Kristine at kristine@beacon-advisor.com.

“We had a responsibility to protect middle class families from a tax increase that would have hit their paychecks and harmed the recovery”

Nothing like waiting til the last minute…

Financial advisors have been preparing their clients for higher taxes as we waited for Congress to do something to stop the Bush era tax credits from expiring at the end of this year.

Given the slow recovery the economy is experiencing an increase in taxes that would have resulted had the Bush tax cuts not been extended would have been a tough blow, especially for the middle income class.

Congress finally passed a bill that would extend the Bush tax cuts, as well as introduce a few new ones.  The bill, called the Tax Relief Unemployment Insurance Reauthorization and Job Creation Act of 2010 is expected to be signed by President Obama later today.

Here are some of the highlights of the new tax bill:

• The current tax rates have been extended for two years.  They were scheduled to go up in 2011.  The 10% bracket was going to disappear, and most of the other tax brackets were going to go up, which would have been devastating to taxpayers in this economy.  Hopefully the economy will have grown and will be stable before tax rates do go up in 2013.
• The current capital gains and dividends rates have been extended through 2012.  This will give many people an opportunity to sell positions that have a gain before capital gain rates go up.
• The Alternative Minimum Tax (AMT) exemption will remain at the higher levels for two more years, giving relief to middle income taxpayers who would have to pay AMT without this band-aid.  I’m still looking for permanent AMT changes in the future.
• The new tax bill includes a payroll tax deduction for workers.  Workers will get a 2 percentage-point break on their payroll tax for one year. Instead of paying 6.2% on wages up to $106,800, they will only have to pay 4.2% in 2011.
• Unemployment benefits will be extended for another 13 months, giving people who have been unemployed for an extended time period more time to find another job (with unemployment rates still close to 10% this was to be expected).
• The estate tax has been reinstated for 2011, but the top tax rate will be 35% and the exemption amount will be $5 million per person and $10 million per couple.  Without this tax bill, the estate tax would have been reinstated at 55% with only a $1 million exemption.

These are just a few of the provisions included in the new tax bill.  The response to the new tax bill has been mixed.  Some economists say this bill will boost economic growth and create millions of jobs.  Others are calling this bill “weak stimulus”.  While I’m not sure how much this bill will boost the economy, I do believe that if the Bush tax cuts were allowed to expire the higher taxes that would have resulted would have been very difficult for taxpayers in this struggling economy.

For more information on the new tax bill and how it will affect you, please visit Tax Cut Deal: How it Affects You at CNNMoney.com.

Why so much focus on Roth IRAs this year?  The rules that determine who can convert a traditional IRA to a Roth IRA have been changed which will allow more people to convert to Roth IRAs.  Before 2010, only people with modified adjusted gross incomes of less than $100,000 could convert.  Starting in 2010, this income limitation has been lifted, meaning most people are eligible to convert their traditional IRAs to Roth IRAs.

In addition to the income limitation being lifted, the IRS is allowing taxpayers who do a Roth IRA conversion in 2010 to spread their taxes out over two years.  So instead of paying it all on your 2010 tax return, you can pay half in 2011 and half in 2012.

This may seem like a no-brainer for people who want to do a Roth IRA conversion in 2010, but don’t leap before you look.  Just because you can do a Roth IRA conversion in 2010 doesn’t mean you should do a Roth IRA conversion in 2010.

Before you make a decision on whether to convert or not, here are some basics about traditional and Roth IRAs you should be aware of:

Traditional IRAs

• Money put into traditional IRAs is tax deductible (income limits apply if you are covered by an employer sponsored retirement plan)
• Withdrawals from traditional IRAs are taxed at your ordinary income tax rate, so if you are in the 15% tax bracket you’ll pay 15% on the amount withdrawn, if you’re in the 28% tax bracket you’ll pay 28% on any distributions, etc.
• Distributions must be taken from traditional IRAs once you reach age 70 1/2.

Roth IRAs

• Contributions to a Roth IRA are not tax deductible.
• Your ability to contribute to an IRA may be limited if your income is high.
• Qualified withdrawals (must be at least age 59 1/2 and have had the Roth for at least five years) are not subject to income tax.
• Roth IRAs are not subject to the required minimum distribution rule that traditional IRAs are.

As you can see, there are benefits and drawbacks to both types of IRAs, so how do you know which one is right for you?  Here are some general guidelines to help you determine whether a traditional or Roth IRA makes the most sense for you:

• If you expect to be in a higher tax bracket when you will need the money, then a Roth IRA probably makes more sense.
• If you think you will be in a lower tax bracket when you retire, then a traditional IRA may make more sense as you’ll get a tax break up front when your tax rate is higher.

So Should You Do a Roth IRA Conversion in 2010?

Many people are not able to contribute to Roth IRA accounts because their income is too high.  Thanks to the income limit for Roth conversions being lifted in 2010, taxpayers who didn’t have access to Roth accounts before can invest in them now by converting their traditional IRAs.

Because of the tax advantages of Roth IRAs, when you convert a traditional IRA to a Roth IRA, you have to pay taxes on the entire amount converted.  This can be a substantial tax bill depending on how much you convert and what tax bracket you are in.

Despite the fact that you have to pay taxes on the amount you convert, it may still make sense for some people to do a Roth IRA conversion in 2010.  You should consider converting to a Roth IRA if:

• You expect to be in the same or higher tax bracket when you retire (or when you will need the funds),
• You have a long time horizon for the funds that will be converted, and
• You have funds outside of the IRA to pay the tax resulting from the conversion.

While Roth IRA conversions won’t be right for everyone, some people will benefit from the new 2010 conversion rules.  The people who will benefit the most include people who have been unable to contribute to Roth IRAs due to income limits and people who expect to be in a higher tax bracket when they retire (or who are convinced that tax rates will continue to go up regardless of which bracket you are in).

A financial planner can help with a number of financial questions and goals, such as reviewing your investments to make sure they are appropriate to meet your goals, preparing a retirement projection to show you if you are on track to retire at your desired age or not, reviewing your tax returns to make sure you’re getting all of the tax benefits you are entitled to, or even a comprehensive financial plan which covers all aspects of your financial life.

There are many different types of financial advisors, and most are compensated differently and work differently than other advisors (there’s not a standard fee structure or even a standard service set when it comes to financial advisors), so it’s important to do your homework before you hire a financial professional.

Here are some questions you should ask when interviewing a financial planner:

• How long have you been providing financial advice?
• How are you compensated? Do you earn a commission for products your recommend (sell) or do you earn a fee based on your time?
• What are your qualifications? Do you have any licenses (CFP, CPA), or are you associated with any professional organizations (NAPFA, FPA, etc.)?
• Who are your typical clients? Do you have any clients similar to me?
• Do you have a specialty, i.e., tax planning, retirement planning, working with baby boomers?
• How often will you monitor my financial plan? Do you automatically monitor my investments or is it up to me to contact you when I need an update?
• How many clients do you have? Will I be working with you or an associate of yours?

While asking friends, family and business associates for referrals for financial planners is a good idea, you should do your own due diligence as well. Read up on the different types of financial advisors (stick with reputable financial publications and websites such as the Wall Street Journal, Kiplinger’s Magazine, etc.) before you start your search. Once you know what type of advisor you want to work with, you should interview several potential advisors to determine which one will best suit your needs, personality and goals.

Beacon Financial Advisors is one of several financial advisors in Kansas City who offers hourly, fee-only financial advice. For objective, unbiased advice on your investments, retirement, taxes and more, please contact us to setup a complimentary introduction meeting today.

If you are retired and receiving Social Security benefits, you know that your benefits are increased each year to help you keep up with inflation.  This is called a cost of living adjustment, or COLA.  The COLA is announced in October of each year and is based on the CPI-W (the Consumer Price Index for Urban Wage Earners and Clerical Workers) from the 3rd quarter of the previous year to the 3rd quarter of the current year.  Changes announced in October go into effect in January of the next year.

In 2009, retirees saw their benefits increase by 5.8%, due mainly to the high cost of gas during 2008.  This was much higher than normal, with the average increase being around 2.8%.  Unfortunately, the Congressional Budget Office (CBO) is estimating that there will be no increase in Social Security benefits for the years 2010 through 2012.

The reason that there may not be any COLAs for the next few years is a law that says that no further COLAs may be given until the CPI-W exceeds the level on which the previous adjustment was based.  Since gas prices have gone back down, the CPI-W has also decreased and is not expected to get back to the level it was at (when the 2009 COLA was announced) until the year 2011.

If you’re already receiving Social Security, you probably are also aware that Medicare Part B premiums have also been rising.  Thankfully, there is good news for the majority of retirees who have their premiums deducted from their Social Security checks.  There is a “hold harmless” provision that says that Social Security retirement benefits will not decrease as a result of an increase in the Part B premium.  So even if Social Security benefits stay the same and Part B premiums increase, your Social Security check will not go down.

However, the “hold harmless” provision does not apply to new Social Security recipients, Medicare participants who are not yet receiving Social Security benefits and high income people.  If you are unfortunate enough to fall into any of these groups, you’ll pay higher premiums to make up for the participants who are covered under the “hold harmless” rules.  This may seem unfair, but this scenario (where Social Security does not receive a COLA but Medicare premiums are rising) was never expected to happen, because it was never expected that Social Security would not receive a cost of living adjustment since they were made automatic in 1975.

The reason high income earners will see higher Medicare premiums is due to the Medicare Modernization Act, which will be completely phased-in this year.  This act basically says that high income beneficiaries will pay a larger portion of the cost of Medicare, based on their income.  While this act is not the focus of this article, the combination of the Medicare Modernization Act with no COLAs for Social Security retirement benefits could mean smaller Social Security checks for people above certain income levels for the next few years.

Bottom line, if you’re collecting Social Security you’re going to learn the true meaning of “fixed income” over the next few years.  To prepare you should keep a close eye on your spending, and if you’re a high income earner you should be aware of tax and financial planning strategies that could cause a spike in income and thus a spike in your Medicare costs.  These strategies need to be carefully planned and coordinated so that your increase in Medicare costs don’t outweigh the benefits of the planning strategies.

Financial Advisors in Kansas City – Beacon Financial Advisors is a fee-only financial planning firm located in Lee’s Summit, serving the greater Kansas City area.  Services provided include retirement planning, investment advice, tax planning and comprehensive financial planning.

Will Social Security be there for me when it’s my time to collect benefits?

For a long time the media has been telling us that Social Security is going bust. Millions of Americans depend on Social Security to fund all or part of their retirement, so this is a huge concern in our country. So do we really need to worry about Social Security going under before we start collecting our retirement benefits?

The 2009 Social Security Trustees Report anticipates that Social Security benefits paid to retirees will exceed Social Security taxes paid in by workers (and earnings on the funds in the trust) beginning in 2016.  In addition, the trust fund could be exhausted by 2037.  Once the trust fund is gone, benefits will still be paid out, but the taxes collected from people still working will only be enough to cover 76% of the benefits promised.

We will probably see several reforms in the future, including a higher retirement age, decreased benefits for future retirees, etc.  Social Security may not look the same as it does now for future generations, but it’s too important to our country to let it fail.

How much can I expect to receive?

An important part of planning for retirement is knowing what resources you will have to help cover living expenses once you retire. For some people Social Security is their only retirement income; for others it’s a small part of their retirement, as they will have pensions and investment income in addition to Social Security. Whatever your situation is, you need to have a good understanding of how much income you will receive from all sources so you can adequately plan for your retirement years.

How much Social Security you receive will depend on several things, such as when you retire, how many years you worked and how much you earned, among other factors.

Generally, your benefits are calculated by applying a formula to your top 35 years of earnings, indexed for inflation. Once your benefit is calculated, it is reduced by up to 25% for people who retire before their full retirement age, and increased by 8% per year for people who wait until after their full retirement age to start collecting benefits. To estimate your benefits, you can use the retirement benefit calculators at the IRS website.

When should I sign up for Social Security?

Probably the most commonly asked question is “when should I sign up for Social Security”? By now, you’re aware that you will receive lower benefits if you apply for Social Security before your full retirement age. The question is, are you better off applying early and receiving benefits for more years, or will you benefit more if you wait until age 66 or later to apply?

How can I get the maximum benefits?

Your parents and grandparents probably never wondered how they could maximize their Social Security benefits, but you should. Because it’s an income stream for life, and because it is increased each year for inflation, Social Security is much more valuable than most people realize. There is nothing wrong with using the Social Security rules to your advantage.

Will my Social Security retirement benefits be enough to live on?
Social Security was never meant to fund 100% of your retirement. It was designed to supplement other income streams (pensions and annuities) as well as your retirement savings.  So you should not expect Social Security to be enough to cover all of your living expenses in retirement. On average, Social Security constitutes about 40% of their income.

Congress approved legislation this week that will provide some relief to Americans over 70 1/2 who have suffered significant losses in their IRA accounts.  The bill will temporarily suspend the excise tax that is levied when seniors fail to the the required minimum distribution (RMD) from their retirement accounts.

This penalty is waived for 2009, which means that seniors will not be required to take withdrawals from their tax deferred retirement accounts during 2009, which will hopefully give these accounts time to recover before the 2010 required distribution.  Unfortunately, this law does not apply to 2008 when it would have made the most difference to investors who have lost significant amounts in their accounts.

If you’re not familiar with the RMD, basically taxpayers who are age 70 1/2 must take annual required minimum distributions from their tax-deferred retirement accounts, including traditional IRAs, 401Ks and 403Bs.  The amount is based on your life expectancy and the prior December 31 balance of your account.  Failure to withdraw this amount and you will be levied a 50 percent penalty on the amount that you should have withdrawn… and this is in addition to your regular income tax!

Surprisingly, there is still talk that the RMD for 2008 will be suspended.  If relief is passed for 2008, taxpayers who have already taken their distributions will be allowed to re-contribute those funds so they don’t have to pay taxes on them.  We should know by mid next week if the 2008 RMD is also suspended.

Do an AMT sweep: One of the reasons why it’s wise to consult a tax adviser before you start accelerating deductions is that certain people over $75,000 find themselves more susceptible to the alternative minimum tax if they proceed. The AMT is an alternative taxation process that’s figured separately from your regular tax liability and you have to pay whichever tax is higher. State and local income taxes and property taxes, for example, are not deductible when figuring the AMT. Under the regular rules, medical expenses that exceed 7.5 percent of adjusted gross income can be deducted under the regular rules, but under the AMT, that threshold is 10 percent. Also, under regular rules, interest on up to $100,000 of home-equity loan debt is deductible no matter how the money is used, but under the AMT, the deduction holds only if the money was used to buy or improve a primary or second home. It pays to check your AMT risk before you execute any end-of-the-year tax-savings strategy.

Check investment gains and losses: After the market drops we’ve seen this year, it’s likely you have some capital losses in your taxable investment accounts.  It might make sense to sell and offset them against any capital gains you’ve realized this year. Such losses can offset 100 percent of capital gains plus up to another $3,000 in ordinary income. Any losses in excess of that number can be carried forward to the next tax year.  Note: According to Morningstar.com a lot of mutual funds are expected to distribute capital gains to shareholders, despite funds being down 30-40%.  Check your mutual funds to see if you are expected to receive a capital gain distribution; if so, it might make sense to do some tax loss selling before the December distribution to avoid another taxable event.

Prepay property taxes: If your income is higher in 2008 than in previous years (or higher than your expected 2009 income), it might pay to accelerate deductions.  If so, make sure you pay your property taxes before the end of the year.  If you typically pay property taxes early in the next year, consider pre-paying those expenses so you can deduct them on your 2008 tax return.

Prepay state taxes: Again, if it makes sense based on your tax situation, consider making your fourth-quarter estimated state tax payment in December instead of in January so you can take the deduction on your 2008 return.

Defer income if possible: Self-employed people and some business owners might elect to invoice customers in January so they don’t have to include that income on their 2008 return. Keep in mind that it only makes sense to defer income if you think you will be in the same or lower tax bracket next year.

Plan a stock donation to charity: If you have stock with a large unrealized capital gain that you’ve held longer than a year (Okay, I realize most stocks didn’t have a gain this year, but if you have stocks you’ve held for a long time, it’s possible you still have a gain), you can give that stock to a qualified charity and claim a deduction for the current fair market value of the security. If you have a stock with an unrealized capital loss, do the opposite – sell the stock, claim the capital loss, then donate the resulting cash proceeds to charity. This is actually better than just donating cash, because you get the same deduction and never have to pay the capital gains taxes from the appreciated security.

Make sure donations are documented: As of January 1, 2007, you now must have a either a receipt or a canceled check to back up any contribution, regardless of the amount. If you don’t have such a written record, the IRS will reject the write-off if the lack of proper record keeping is discovered in an audit.

Charitable giving is an important part of tax planning at year-end, so let’s look at the cash and noncash aspects of giving. It makes sense to contact a tax expert or financial planner to talk about what giving makes sense for you:

You have to itemize: Only individual taxpayers who itemize their deductions on Schedule A can claim a deduction for charitable contributions. This deduction is not available to people who choose the standard deduction, including anyone who files a short form (1040A or 1040EZ).  However, there has been talk about allowing “above the line” charitable deductions, so I’m hopeful that this tax law will change soon.

Get out the checkbook: Uncle Sam likes a record. To deduct any charitable donation of money, a taxpayer must have a bank record or a written communication from the charity showing the name of the charity and the date and amount of the contribution – and it definitely helps to have both. Bank records mean canceled checks, bank or credit union statements and credit card statements. Bank or credit union statements should show the name of the charity and the date and amount paid. Credit card statements should show the name of the charity and the transaction posting date. For payroll deductions, the taxpayer should retain a pay stub, Form W-2 wage statement or other document furnished by the employer showing the total amount withheld for charity, along with the pledge card showing the name of the charity. If you remember the IRS being satisfied with personal bank registers or scribbled notes to document the donation, they’re not anymore.

There are charities, and then there are charities: You need to make sure that organizations are qualified to make tax-deductible contributions to. IRS Publication 78, available online and at many public libraries, lists most organizations that are qualified to receive deductible contributions, but there’s an online version too. Just go to IRS.gov and type in “Search for Charities.” One key exception — it’s important to note that churches, synagogues, temples, mosques and government agencies are eligible to receive deductible donations, even though they often are not listed in Publication 78.

Giving away property: If you give away property, including clothing and household items, get a receipt that includes a description of the donated property. If a donation is left at a charity’s unattended drop site, keep a written record of the donation that includes a description of the property and its condition. For any kind of vehicle, boat or airplane, the deduction is now limited to the gross proceeds from its sale. This rule applies if the claimed value of the vehicle is more than $500. Form 1098-C, or a similar statement, must be provided to the donor by the organization and attached to the donor’s tax return.  (Note: I have a valuation guide to help you assign values to clothing, furniture and other items typcially donated to charity.  Please email me if you’d like a copy of this guide.)

You can’t deduct junk: Under a provision of the 2006 Pension Protection Act, contributions of physical items must be in good used condition or better to qualify for a deduction. That means that you can’t deduct ripped or discolored clothing or appliances that don’t work. Also, if you donate noncash property that is valued at more than $500, you need to report to the IRS how and when you acquired the property and your cost basis. You must file Form 8283, Noncash Charitable Contributions, for all donations of property valued at more than $500.

Use that digital camera: If you’re ever audited, it helps to have photographs or video of these items along with your detailed receipt.  A good idea is to take pictures of the items you are donating and staple prints to your written record.

Learn rules about giving away appreciated securities: This is where a financial planner or tax expert would come in handy.  When you donate stocks or mutual fund shares you have held for more than one year, generally you may deduct the stocks’ current fair market value. Additionally, you avoid paying capital gains taxes on the appreciated value.

Donate your RMD to charity: The Pension Protection Act of 2006 allows IRA owners who are over age 70 1/2 to make direct transfers of up to $100,000 per year from their IRA to a charity. The provision became available for IRA distributions taken after Aug. 17, 2006 and originally only applied to distributions through the end of 2007, but has been extended for 2008 and 2009 thanks to the Emergency Economic Stabilization Act of 2008.  Distributions can be made from taxable funds in an IRA or Roth IRA, but not from employer plans or SEP and SIMPLE IRAs. The distribution will not be taxable and there is no charitable deduction allowed on the tax return.

November 2008 — This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided (and edited) by Kristine McKinley, CPA, CFP, a local member of FPA.

Similarly, if you’re investing for long-term goals such as retirement, you will encounter some market volatility, probably several times along your journey.  While you may be tempted to pull over and wait out the rough times, it will delay or may even prevent you from reaching your goals.

So what should you do when the road to investing gets bumpy?

Buy Low, Sell High:  The whole premise behind investing is to buy low and sell high.  You can’t do that if you pull out of the market or stop investing when the market goes down.  If you’re investing for the long-term, you should be glad when the market is down, because then stocks are “on sale” and you can pick up more shares at a lower price.  Who doesn’t love a good sale?

Diversify: One of the best ways to defend your portfolio against market losses is to have a portfolio that is properly diversified.  If you review the history of the stock market, you’ll see that the best performing assets vary from year to year and that it’s not easy to predict which asset class will perform well in any given year.  Therefore, by having a mix of asset classes, based on your risk tolerance, your goals and your timeframe, you are more likely to meet your goals.  In addition, having a mix of asset classes reduces your risk of loss, since you won’t have all of your eggs in one basket.

Rebalance Once a Year:  Just like keeping your car maintained, you should review and rebalance your portfolio once a year.  You should have an asset allocation that is right for your risk tolerance, goals and time frame.  Once a year, you need to review your portfolio to ensure that your assets are still allocated properly to meet your goals.  Doing this periodic maintenance will help ensure that your portfolio performs well on a long-term basis, and will help you reach your investment goals.

Stay the Course: When the market gets volatile, your best bet is to stay the course. If you pull out of the market when it’s down, you could do more harm than good.  In addition, if you pull out of the market with the intent of getting back in when the market recovers, you will likely miss the best days, months or even years of the market, which could result in a much smaller nest egg than if you had just stayed in the market.

It’s normal to be nervous when the market gets volatile, but it’s important to continue to follow your long-term investment plan so that you remain on the road to reaching your financial goals.