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Tax Diversification for a More Secure Retirement

Just as you allocate assets to a combination of stocks, bonds, cash, and other investments, you may want to consider allocating retirement assets among tax-deferred, tax-free, and taxable accounts for a potentially greater retirement income.

FIRST TAKE ADVANTAGE OF TAX DEFERRAL

Like many Americans, you probably have most of your retirement savings in a traditional 401(k) or similar tax-deferred retirement plan. The benefits of tax-deferred plans have been proven time and time again. You save federal and possibly state income tax while contributing, and your contributions grow tax-deferred until you withdraw them at retirement when many people expect to be in a lower tax bracket.

But that’s the sticking point. If you’ve been successful in business, at retirement time, you may find that you aren’t in a lower tax bracket than you were when you were working. You could lose some of that tax-deferral advantage.

ADD TAX-FREE ACCOUNTS

With Roth 401(k) accounts and IRAs, you invest with after-tax dollars and gain no current tax benefit, but you’ll owe no income or capital gains tax on any withdrawals you make during retirement. Another tax-free vehicles to consider is municipal bonds, which offer income free from federal income tax and state income tax if they are issued in the state where you reside. However, the interest earned may be lower than possible with Roth accounts.

AND A DASH OF TAXABLE ACCOUNTS

Taxable accounts offer a wide range of investment choices, including stocks, bonds, mutual funds, and real estate. They also require you to invest with after-tax dollars and pay taxes every year on any income you earn or capital gains you realize.

As the old TV commercial said, “It’s not what you make, it’s what you keep.” Tax diversification can spell the difference between having income choices or having taxes force you to downgrade your lifestyle. Note: Tax diversification isn’t a DIY strategy. It requires a thorough understanding of tax codes and your overall financial situation.

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Child and Dependent Care Tax Credit

Parents paying for school-age children’s day camp this summer may be eligible for the federal child and dependent care tax credit (CDCC). Note that it’s available only for the expense of day camp, not overnight camp. But there is more to it.

WHO QUALIFIES?

The CDCC generally helps parents or caregivers cover the cost of qualified care expenses for a child under age 13 or a spouse or other dependent (a parent, for example) who is mentally or physically unable to care for themselves and will have lived with you more than half of 2024.

HOW MUCH?

You may deduct only a percentage (20% to 35%) of qualifying expenses. For anyone with $43,001 or more adjusted gross income in 2024, that percentage is 20%. The credit is further capped at $3,000 a year for one dependent or $6,000 for two or more.

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The Time for Succession Planning is Now

The busiest, most successful business owners recognize the importance of having a business succession plan. But long hours can keep owners from conducting periodic reviews of the plan to help ensure it continues to address succession goals, both operational and financial. Here are some items to review that you might not readily think of.

ON THE OPERATIONAL SIDE

Multigenerational family ownership is not necessarily the cure for an operational succession plan. Emotions aside, start by analyzing key employees/positions and how a disruption, such as the potential loss or unavailability of current vital employees, would affect the business. Develop a strategy defining the roles to be assumed by second or third-generation ownership, and provide training.

Also review facilities and consider how the business would operate if one or more of your current locations or critical systems become unavailable. Review the business’s current mechanisms to protect, secure, back up, and, if necessary, replicate critical data systems, infrastructure, and applications. Technological change is constant.

ON THE FINANCIAL SIDE

While you probably have a general sense of the value of your businesses, scheduling an independent appraisal will enable you to know the value. And, of course, you should review any insurance, cross-purchase, entity-purchase, or other agreements in place for transferring business assets to family or partners.

If you have any personal guarantees on business loans, the issue needs to be resolved with lenders before there’s a problem. In a worst-case scenario, these loans could get called shortly after a majority owner/operator passes away. That could be a significant hardship for a business trying to succeed with a prearranged financial succession plan.

Your strategy should also include how any business real estate will be handled. Will it remain with the heirs, go to partners, or will new owners also buy the real estate? A formal valuation of real property generally should be made and updated every five years or whenever there’s a material change in facts or circumstances.

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May 2024 Client Line Newsletter

The Time for Succession Planning is Now – the busiest, most successful business owners recognize the importance of having a business succession plan.

Child and Dependent Care Tax Credit – parents paying for school-age children’s day camp this summer may be eligible for the federal child and dependent care tax credit.

Tax Diversification for a More Secure Retirement – you may want to consider allocating retirement assets among tax-deferred, tax-free and taxable accounts.

May 2024 Client Profile

The Market’s Obsession with the CPI – it seems the stock market has become obsessed with the Consumer Price Index.

May 2024 Question and Answer

Protect Your Security Data – often, data security concerns surface when an employee leaves.

Cutting the Financial Cord – in a 2023 Credit Karma survey, nearly a third of parents with children over 18 reported providing them with financial support.

May 2024 Short Bits

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Considering Unretiring?

1 in 6 retirees are considering a return to work and more than half of them want remote positions, according to a 2023 Paychex survey. Financial reasons were a major factor in the majority of responses.

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April 2024 Question and Answer

QUESTION

I recently received a financial windfall and wondered if I should invest it or use the extra money to pay down debt.

ANSWER

It depends. First, pay any income taxes that may be due on the windfall. Then, consider paying off high-interest credit card debt before any lower-interest loans.

Determine whether it makes more sense to pay off a low interest mortgage or home equity loan where you can deduct the interest or make more by investing to get higher returns.

If investing, consider adding to your emergency or retirement fund.

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Claiming Deductions for Volunteer Work

Volunteering helps others and gives you a feeling of satisfaction. And it may also give you a tax deduction. To qualify for a deduction, your expenses must directly relate to the charity where you volunteer. Additionally, you must not have been reimbursed for those volunteering expenses and must itemize deductions.

INCIDENTAL EXPENSES

You may deduct expenses for things like postage, paper, printer ink, or other out-of-pocket costs incurred while volunteering. The cost of gear or a uniform, and possibly cleaning services may be deductible.

Any expenses the nonprofit reimburses are not deductible.

TRAVEL

If you use your car for volunteer work, you may be able to deduct 14 cents a mile or the cost of your unreimbursed gas but not your car’s maintenance. Other reasonable travel expenses will be tax deductible if tied to your volunteer work. Meals for volunteer service are 100% deductible.

RECORD KEEPING

You need to substantiate your volunteer expenses. So, as with any deductible expense, keep accurate records. Retain any paper and electronic
receipts and keep a mileage log. This will help make tracking expenses and providing the details to your tax professional at tax time easier.

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April 2024 Client Profile

Jack retired early and began receiving Social Security benefits. Now he misses working. Can he stop his benefits and start them again in a few years?

Since it’s been more than 12 months since Jack started receiving benefits, he’ll have to wait until he reaches full retirement age to suspend his benefits. Fortunately, that’s only a couple months away.

Temporarily suspending his benefits will then earn him delayed retirement credits and a higher monthly benefit when he resumes payments. When he fully retires, his Social Security benefits will also be boosted by not being subject to federal income tax as they might be if he works and collects benefits.

It’s different for someone who started receiving Social Security within the last 12 months. They’d need to file IRS Form SSA-521, essentially making their situation as if they’d never received benefits (other requirements may apply). And, they’d have to pay back everything they’d received in benefits.

Client Profile is based on a hypothetical situation. The solutions discussed may or may not be appropriate for you.

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Is Alimony Taxable?

For federal income tax, the answer is “Yes” and “No,” depending on your divorce agreement date or last modification.

THE RULES

Generally, for agreements entered before January 1, 2019, alimony (separate maintenance payments) is taxed to the recipient spouse and deductible by the payor. The payor doesn’t have to itemize deductions to claim alimony paid. However, for agreements entered in 2019 and later, alimony is neither taxed to the recipient nor deductible by the payor.

AVOIDING TAXATION

If your divorce was before 2019, you can avoid future tax on alimony you receive by having your legal professional amend your agreement. The amendment must explicitly spell out that the repeal of the deduction for alimony payments now applies to payments under your divorce agreement.

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Too Young to Need Life Insurance

What’s your excuse for not having life insurance? For many younger people, it’s cost. About a third of Gen Z and 39% of millennials think they can’t afford life insurance — with many overestimating that $250,000 of term life insurance for a 30-year-old would cost $1,000 or more a year.*

COST

Securing life insurance in your 20s or 30s can be advantageous and more affordable than you think. For example, a $500,000 term life insurance policy might cost you only $30 a month at 25. At age 45, you could have to pay more than $100.* So, taking care of insurance needs while you are young could save you thousands of dollars over time.

GET REAL

The question becomes, “Can you afford not to have proper coverage? It may sound harsh, but do you want to saddle your spouse, partner, or parent with mortgage payments (even for a limited time), other debts, and funeral expenses at a time when they’re grieving and have other life adjustments to worry about?

Life insurance becomes even more critical if you have or plan to have children. You have their future to consider. Talk with your financial professional soon about your life insurance needs.

*Source: LIMRA.com, 2023