Tax smart actions you can take throughout the year - Fidelity … · 2019. 10. 11. · IRA has high cost basis When IRA has low basis and owner has NOL, large charitable deductions

Tax smart actions you can take throughout the year

10 September 2019

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The benefits of being tax-smart throughout the year

Agenda

► Contributing to an IRA to help reduce

your taxes and put money away for

retirement

► How a 529 plan can fit into your plan

► State tax residency planning


IRAs


Traditional Roth

Contributions Pre-tax/deductible* After-tax

Tax-deferred growth Yes Yes

Tax benefits Now* Later

*IRA contributions may or may not be deductible depending on individual circumstances

Comparing traditional and Roth


IRAs: Eligibility and contributions

Traditional IRA Roth IRA

Ability to

Contribute

► Must have earned income

(non-working spouse is eligible to contribute)

► Must have earned income

(non-working spouse is eligible to contribute)

►2019 AGI Phase Out

►Single & HOH: $122,000 - $137,000

►MFJ: $193,000 - $203,000

Maximum

Contributions

►$6,000

►$1,000 catch-up for those age 50+

Contribution

Deductibility

► 2019 AGI Phase Out – You

►Single & HOH: $64,000 - $74,000

►MFJ: $103,000 - $123,000

► 2019 AGI Phase Out – Spouse

►MFJ: $193,000 - $203,000

►Not deductible

Taxation of

Distributions

►Ordinary income on before-tax contributions

and earnings

►10% penalty may apply if under age 59 ½

►Tax-free qualified distributions

►Non-qualified distributions may be subject to

tax and/or penalty


Three good reasons to contribute to a traditional IRA

1. You want to deduct your

IRA contributions

2. You expect to be in a lower

tax bracket in retirement

3. You can’t fully contribute to

a Roth IRA


Four good reasons to contribute to a Roth IRA

1. Your employer doesn’t offer a

401(k), or offers one without a

Roth feature

2. You expect to be in a higher tax

bracket in retirement

3. Your ability to deduct traditional

IRA contributions is limited or

prohibited

4. You prefer not to be subject to

RMDs


• Catch-up contributions for those age 50+

• Spousal IRA available for non-working spouse

• Contributions can be made through April 15 of the following year

– Traditional: tax-deferred growth and possible current year tax deduction

– Roth: tax-free retirement income; no current year tax deduction

Contributions

• Ordinary income tax on pre-tax contributions and earnings during the year of conversion

Roth Conversion

IRA opportunities


Roth for children

► Gift up to $6,000 to children

► Do they have earned income?

► Are they under income limitations (MAGI)?

► Single: $122,000 - $137,000

► MFJ: $193,000 - $203,000

► Roth IRA qualifies for annual gift tax exclusion but provides some potential protection for assets from kids being kids


Roth conversion


What is a Roth conversion?

A transfer of assets from

a traditional account

to a Roth account► Balances are thereby “converted”

to a Roth account

► Once converted, balances in the

Roth account enjoy all the

features of a Roth


What are the tax implications at the time of a Roth conversion?

Pretax balances and

earnings are subject to

ordinary income taxes

No tax penalty regardless

of age


Roth conversions: Point counterpoint

► Owner can pay the tax on conversion from

non-account assets

► Assets will pass to non-charitable beneficiaries

► When the investment horizon is longer and/or

wealth transfer to heirs is a priority

► Assets will appreciate

► When the owner anticipates that their income

tax rates will stay the same or increase

► Owner needs to take a distribution from the IRA

to pay tax on conversion

► Assets will be used to fund charitable bequests

at death

► When the investment horizon is shorter

(e.g. assets will be spent in retirement)

► Assets will depreciate

► When the owner anticipates that their income

tax rates will decrease significantly

Conversion makes

more sense

Conversion makes

less sense


Roth conversions: Point counterpoint

► High bracket taxpayer subject to AMT in year

of conversion

► IRA has high cost basis

► When IRA has low basis and owner has NOL,

large charitable deductions or other items that

will shelter the income from the conversion

► High bracket taxpayer who may be in AMT in

a subsequent year

► IRA has low cost basis creating significant tax

liability on conversion

Conversion makes

more sense

Conversion makes

less sense

► Caution: Can no longer unwind a Roth IRA conversion


Marginal tax rate

The ever-changing tax landscape


Highest rate Lowest rate

1926 1936 1946 1956 1966 1976 1986 1996 2006 20262016

20%

40%

60%

80%

100%

529 plans


The average annual costs of college

$0 $10,000 $20,000 $30,000 $40,000 $50,000 $60,000

Public two-year in-district commuter

Public four-year in-state on-campus

Public four-year out-of-state on-campus

Private nonprofit four-year on-campus

Tuition Room and board Books and supplies Transportation Other expenses

Source: College Board, Trends in College Pricing, 2018


Sources of college funding

Family income and savings

48%Scholarships and grants28%

Borrowing24%

Parents: 34%

Students: 14%

Scholarships: 17%

Grants: 11%

Students: 14%

Parents: 10%

Source: Sallie Mae, How America Pays for College, 2018


College savings vehicles

529 savings plans

529 pre-paid plans

Coverdell education savings

accounts (ESA)

Series EE and I bonds

Custodial accounts

IRAs

Taxable accounts


529 savings plans

Taxation► Contribution: Possible state tax

deduction

► Growth: Tax-deferred

► Distribution: Tax-free (if qualified)

Investments► Low fees

► Age-based, risk-based, and other

investment options

Other features► Low impact on financial aid

► Ability to change beneficiary


Tax benefits of 529 plans

Savings grow tax-deferred

Federal tax-free withdrawals for

qualified education expenses

Beneficiary can be changed at

any time

Potential state tax savings on contributions

and withdrawals


You can change the Beneficiary to someone who is recognized by

federal tax law as a family member of the original Beneficiary.

Qualified tuition programs – 529 plans

529 plans

College savings plans

Pre-paid tuition plans


529 Pre-Paid Tuition Plans and 529 Savings Plans

529 Pre-paid Tuition Plans 529 Savings Plans

Objective• Lock in the current cost of education

• Save without bearing investment risk

Choice of investments to help accumulate assets

Eligibility Some states require residency

Contributions High contribution limits

Federal taxation• Tax-deferred growth

• Tax-free qualified distributions

• Tax-deferred growth

• Tax-free qualified distributions

Investment choices Plan bears the investment risk Determined by each plan

Control Owner maintains control

Effect on Aid5.64% included in Expected Family Contribution

(EFC) calculation, assuming parent is owner5.64% included in EFC calculation, assuming parent is owner

Other

• May be used at any qualifying school (benefit

may be less if used at a non-qualifying school)

• Non-qualified distributions of earnings subject to

ordinary income tax and 10% penalty

• May be used at any qualifying school

• Non-qualified distributions of earnings subject to ordinary income

tax and 10% penalty

When to consider

• Low tolerance to investment risk

• Believe cost of education will rise faster than

returns on investments

• Moderate to aggressive risk tolerance

• Long-term time horizon

• Want ability to save large sums


State tax considerations


What do you need to know about state income taxation of residents/non-residents?

► State tax rates generally

► How states tax residents and non-residents

► How various types of income are taxed

► What you need for filing state returns

► Planning opportunities


State income tax rates

None Low (1–4%) Medium (4–7%) High (>7%)

Source: Federation of Tax Administrators


State tax considerations – how states tax residents and non-residents

► What state(s) do you need to pay tax to?

► Resident taxation

► Domicile

► Statutory residency

► Non resident taxation

► Are there special rules for certain types of income?

► Non-resident taxation and income allocation


Domicile generally

► What is domicile?► “Domicile, in general, is the place that an individual intends to be such individual’s

permanent home – the place to which such individual intends to return whenever such

individual may be absent.”

► A taxpayer may have several residences but can have just one domicile

► Generally, if a person is domiciled in a state, they will be taxed as a

state resident

► However, a person domiciled in a state may be treated as a

nonresident if: ► The person did not maintain a permanent place of abode in the state for the entire

taxable year;

► The person maintained a permanent place of abode outside the state for the entire tax year;

► The individual spent no more than 30 days in the aggregate in the state during the tax year.


Statutory residency generally

► Statutory residency is generally an objective test

► It is a two-prong test:

► Maintaining a permanent place of abode within the state

► Issue: Client purchases a home for a family member but retains title in the client’s name

► Spending in the aggregate more than 183 days in state


Non resident taxation

► States will generally tax the income of nonresidents which is “sourced”

to the state

► Rental income

► Gain on sale of real estate

► Compensation income

► Compensation income

► Allocation of income based on source and period earned

► Generally, only working days are considered in allocation

► See 4 USC §114. Limitation on state income taxation of certain

pension income

► Paying non-resident state income taxes

► Withholding

► Estimated payments


State residency – planning tips

► Documentation, documentation, documentation

► Keep contemporaneous records and calendars

► Thoughtful planning on when change will be made

► Consideration of selling versus keeping home in higher tax state

► If more than two homes – how much time is spent in low tax state

versus state where you were formerly a resident


Questions


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Tax smart actions you can take throughout the year - Fidelity … · 2019. 10. 11. · IRA has high cost basis When IRA has low basis and owner has NOL, large charitable deductions