Monday, August 31, 2015

Self-Employed Can Still Cut 2014 Taxes with a Retirement Plan

Self-employed people—from Uber drivers to high-powered consultants—need to save for retirement, and a tax-advantaged retirement plan is the best way. Designed for the self-employed, the Simplified Employee Pension (SEP-IRA) and the Solo 401(k) are relatively easy to set up. Both plans offer tax-deductible contributions, enabling you to cut your taxes and get tax-deferred growth.   Another plus: you can still reduce your 2014 federal income taxes because either plan allows you to contribute up until your tax-filing deadline, including the six-month extension. If you got an extension and haven’t filed your return yet, you have until Oct. 15 to make 2014 contributions to your plan. 

However, while a SEP-IRA can still be established up until Oct. 15, those who wish to make a profit-sharing contribution to a Solo 401(k) must have established the plan by Dec. 31, 2014. Which plan is best for you? Here are the main features and the pros and cons of each. A SEP-IRA is similar to a traditional IRA. Investment earnings grow taxed-deferred until withdrawal, but self-employed individuals can save and deduct much more than the $5,500 ($6,500 if 50 and over) for contributions to a traditional IRA. SEP-IRA contribution limits are the lesser of 20% of net business income or $52,000 for 2014, $53,000 for 2015. Banks, insurance companies and brokerage firms offer SEP-IRAs, which often can be opened up on the Web. Make sure the sponsor offers a range of solid investment options. 

One caveat: if you have employees, you must contribute the same percentage of salary for them as you do for yourself. If you can’t afford to or don’t want to do that, a SEP-IRA isn’t the best plan for you. Since SEP-IRA contributions are deemed to come from the business, not the individual, a participant can also contribute to a Roth IRA in the same year he or she makes a SEP-IRA contribution. By contributing to both, you can take advantage of tax-free Roth IRA growth and increase the tax diversification of your retirement savings and have more flexibility when you’re taking out money during retirement.   The Solo 401(k) is for self-employed individuals without employees, other than a spouse, who may contribute to the plan if he or she is employed by the business. It can be structured as a traditional 401(k) or as a Roth 401(k). 

The maximum 2015 contribution is $53,000 or $59,000 for those 50 and older. (The 2014 limits are $52,000/$57,500.) The contribution includes: • Annual employee deferral – up to 100% of compensation or earned income for a self-employed individual, to a maximum of $18,000 ($24,000 if 50 or older). This lets some people contribute more to a Solo 401(k) than to a SEP-IRA. • Employer discretionary contribution – up to 25% of compensation as defined by the plan or 20% of earned income for a self-employed individual. An advantage a 401(k) offers over an IRA is that participants may borrow from a 401(k). If you choose a Solo Roth 401(k), you won’t get a deduction, but all withdrawals are tax-free if you wait until age 59 ½. The plan lets you save much more than a Roth IRA.

 Another big plus is that contributions to a Solo Roth 401(k) aren’t subject to income limits, unlike the Roth IRA. Is the Roth or traditional version better? It depends. If you expect to be in a higher tax bracket in the future, the Roth version may make more sense. If your current tax rate is low, you may be better off forgoing a deduction now in order to withdraw money tax-free when you’re in a higher bracket in the future,  . But it doesn’t have to be an either-or proposition. You can have both traditional and Roth 401(k) plans and divide your contributions between them. 

 A Solo 401(k) plan can require more administration than an IRA, especially if the plan allows for loans. A plan with more than $250,000 in assets must file a Form 5500-series return annually. Fortunately, the IRS has simplified some versions of the form, which has reduced the administrative burden for most plans.    Besides the SEP-IRA and Solo 401(k), traditional and Roth IRAs are also an option. In 2015, most individuals can contribute a maximum of $5,500 to their accounts, while those 50 and over can contribute up to $6,500. For most self-employed people, the SEP-IRA is probably a better choice than a traditional IRA because the contribution limits are much higher. 

Furthermore, deductions for traditional IRA contributions are limited by income for participants who are covered by a retirement plan at work or if their spouse is covered by a plan at work. If you’re nervous about tying money up in retirement accounts, it’s good to know you can take withdrawals from a Roth IRA up to the amount of your prior contributions at any time without incurring taxes or penalties. This feature can come in handy in emergencies.

Sunday, August 30, 2015

Small Business Tax Planning Tips for Now

 Most self-employed people or small business owners would never list tax planning as a favorite summertime activity. Yet for those small business owners looking to enjoy a vacation in the next year and some tax-deductible outings during the summer, it makes the most sense.
“Many small business owners don't even think about their taxes until it's time to meet with their accountants and file,” said Terry Rice, owner of Terry Rice,  CPA. “It is to the small business owner’s benefit to meet at least quarterly to analyze how you can take full advantage of the provisions, credits and deductions that are legally available to you. What better time than summertime when things tend to quiet down a bit for many small businesses.”
When it comes to tax planning, Rice cites several overlapping goals that the small business owner should strive for: reducing the amount of taxable income; lowering your tax rate; controlling the time when the tax must be paid; claiming any available tax credits; and controlling the effects of the Alternative Minimum Tax; and avoiding the most common tax planning mistakes.
“Lowering taxable income is the most obvious place to start because if you can accomplish that, you can possibly lower your tax rate,” said Rice. “Three of the better areas to find additional deductions are business entertainment expenses, business auto expenses and the home office expenses.”
One often overlooked deduction for business entertainment is that the IRS allows up to 50 percent deduction of meals. Business must be discussed during that meal and a receipt of the dinner will be needed for tabs greater than $75.
Another is use of more than one personal vehicle for business use. While the 2015 mileage rate of .575 applies, you can deduct business miles from more than one automobile should you use both for business. To figure business use, divide the business miles driven by the total miles driven. This strategy can result in significant deductions.
One last key deduction is the home office, particularly if you need to buy new equipment. Section 179 expensing for tax year 2015 allows you to immediately deduct, rather than depreciate over time, up to $25,000, with a cap of $200,000 (down from $500,000 and $2,000,000, respectively, in 2014) worth of qualified business property that you purchase during the year. The key word is "purchase". Equipment can be new or used and includes certain software. All home office depreciable equipment meets the qualifications.

Saturday, August 29, 2015

Key Considerations When Preparing Your Will

The will to succeed is for naught without the will to prepare. Sounds like a message of exhortation on one of those "success" posters.
Speaking of the will to prepare, have you prepared your will? Take the dog for a walk with a fresh, empty Walmart bag in hand ... or prepare your will? Which would you rather do right now? Hands down (get it?), taking Fido to take care of his business! I get that. In fact, almost anything will win out (I was going to use "trump" instead of the more cumbersome "win out," but did not want to stray into politics), over taking care of your own (legal) business here.  Granted, while it may be an unpleasant task to think about your own mortality, writing a will is one of the smartest financial planning activities you can do. In that spirit, Fox Business solicited some of its contributors regarding important things everyone should know before writing a will. 
Here is an overview of the pooled wisdom from the resulting article titled “3 Things You Should Know Before Writing Your Will.” 
1. A will doesn't actually cover all of your assets. That is correct. Did you know that any assets that have beneficiary designations (e.g., IRAs, 401k’s, and life insurance policies) pass automatically "outside" your will to the designated beneficiaries? In addition, any assets you own in joint tenancy with rights of survivorship with one or more other folks pass to the surviving joint owners at your death. Likewise, pay-on-death bank (POD) and transfer-on-death (TOD) accounts pass to the designated beneficiary when you pass away. Finally, any assets held in trust are handled outside of probate. Teaching point: Make sure your beneficiary designations are consistent with your will. Period. Consequently, if you make changes to your will, then you should review those beneficiary designations to see if similar changes are needed "outside" of it. If you fail to do this, then your well-intended efforts to update your estate planning could create major gaps nosediving your plans for the distribution of your assets after your death into the dirt.
2. Naming your will's executor takes some thought. The executor is the individual in charge of taking care of your affairs and ensuring that your will is carried out as you directed. Selecting the executor is a big deal. Who comes to mind as a potential candidate, as you review the bullet points of executor responsibilities below? Distributing assets as directed by the will. Paying bills and taxes on behalf of the estate. Appearing at legal proceedings for the estate. Maintaining property until the estate settles. Without belaboring the point, you need to choose the right person for this important assignment. Many people select their spouse, an adult child, or a trusted friend. But you can also name an attorney as executor. You also can name joint executors and alternates in case the executor you choose cannot serve or he passes away before you do.  The original article suggests the following considerations when selecting an executor. First, he or she should be someone you trust to make the right decisions, and a person who is smart enough to ask for help from an experienced estate planning attorney when they need it. Second, naming several of your children as co-executors might be hazardous, as this could lead to arguments. However, I think doing so is just dandy, and practical, if the children get along swimmingly.  Your executor need not be a financial guru, but should be a person you trust with good business and common sense.
3. Take extra care in writing your will if you have young children.   In many instances, children cannot deal with the responsibility of inheriting property. Also, if your son or daughter inherits property outright when he or she is still a minor, then the probate court will appoint an individual to be a property guardian if you fail to do so. That on the table, it makes total sense to carefully consider whom you want managing your assets for your child after you pass. This is especially vital because a court-appointed guardian will hand over all the inherited property to your child on the day he or she turns 18. Not good.  Take some time and think about how you want to address these issues. Your estate planning attorney provide help you avoid any additional hidden gotchas and even offer some creative alternatives.
Remember: “An ounce of prevention is worth a pound of cure.” When making your financial, tax and estate plans, do not go it alone. Be sure to engage competent professional counsel.

Friday, August 28, 2015

Young People Need Estate Planning Too


Over the last few months, I have been reading stories of tragic deaths of young people. Most recently the sad passing of Bobbi Kristina Brown (Whitney Houston’s daughter) and the 2 women with wonderful bright futures killed by a gunman at a movie theater in July, Jillian Johnson and Mayci Breaux. Tragedies like these make me think of how precious life is and to consider each day as a gift.

These tragedies also make people in the financial planning industry re-confirm long held beliefs about the need for an estate plan for someone young and single. An estate plan is simply giving you a voice as to what you want done in the event you are not around to speak. An estate plan gives direction to those who are left behind as to how to handle things in the way you would want them to be handled such as:

Do you want a say in how you are medically treated if you are unable to make a decision? I tell my younger nieces and nephews that their mantra is “doing life on my terms.” If that is their mantra, and they do not clearly state what they want done if they cannot make a medical decision, they are literally leaving their lives in the hands of other people. There were reported disagreements as to the medical care of Bobbi Christina Brown. if she had a healthcare directive, she could have stated her own decision and perhaps saved her loved ones a lot of grief and turmoil. If you want to prepare for such an event in your life, you can create a healthcare directive for free at My

Who handles your social media accounts when you are unable to or can’t? I had a dear friend that recently passed away from cancer. One nephew gained access to her Facebook account and started posting information about my friend that I knew she never would have wanted posted. As well intentioned as he was, his posts hurt her family as well as those of us who loved her. Have a list of your social media accounts, user id, passwords and domains and put in writing the person you want to handle your accounts if you passed away. This person should have some experience with computers and dealing with social media.

Who pays for your burial expenses? It is estimated that over 95 million adults in the US do not have life insurance. When you are gone, there are going to be costs associated with burial expenses, time away from work to handle your estate in court, better known as probate, as well as possible costs in removing items from your home. Many will say that if you have no one that is depending on your income then life insurance is not necessary. Consider the people left behind and ensure that there is enough money to at least cover your burial expenses.

What happens to your “Sweet 16” pictures or that trophy you won in junior high? In an ideal world your parents will come together to take care of your things. In reality, there are parents that are not together or are so hostile toward each other that they may fight over your things if you are gone. What may have no monetary value to you may have significant sentimental value to those who love you. Decide who will get the things you own and put it in writing. This is most often done through a will. Many companies offer free estate planning benefits to include will preparation, so start there. If your company does not offer estate planning services you can either pay to have a will done or create a will online using websites like,, or A hybrid approach is to do your will online and then have the will evaluated by an attorney.

What happens to your savings and investments? You probably have at least a bank account and a retirement plan at your job. Make sure you have up-to-date beneficiaries on the latter. You can add beneficiaries to your bank account too by asking the bank for a POD (payable on death) form. A will can take a while for the court to process but with beneficiaries, your heirs just need to show up with a death certificate and some form of ID and they can get immediate access to your accounts.

A tragedy can happen to anyone at any time. Planning for such a moment is admittedly not very fun. But if you really want to live life on your terms, then take action today to make sure that you do that, all the way to the end.

Thursday, August 27, 2015

Inheritance 101: How to Leave Your Home to Your Kids

For many of you, your home is probably your most valuable asset and it's likely that you are very clear about whom you want to end up with it when you die. For example, if you are a parent you probably want your children to inherit your home. However, ensuring that your wishes become reality takes planning --estate planning, specifically. For example, you may:
  • Include your home in your will
  • Transfer your home to a living trust
  • Include the right "magic words" in the deed to your home
There are pros and cons to each of these options, so it's advisable to meet with an estate planning attorney. That way you'll be sure that you choose the option that is best for you based on your finances, your estate planning goals, and other considerations.
1. Include your home in your will
A will is a legal written document in which you specify whom you want to inherit your assets when you die. You may name one person or multiple persons. Each of them is referred to as a beneficiary.
After you die, all of the assets you've included in your will go through a court-supervised process called probate. Among other things, this process ensures that the assets are legally transferred to your beneficiaries according to the terms of your will. Before that can happen, however, any debts you may owe at the time of your death must be paid.
If you designate more than one person to inherit your home, each individual will inherit an undivided interest in it. Therefore, they must decide what to do with the house -- keep it or sell it. And it's possible that they may not see eye to eye. For example, let's assume you left your home to your daughter and son, and that your daughter wants to hold on to it for sentimental reasons, perhaps, but your son has a lot of debt and wants to sell the house so he can use his share of the sale proceeds to pay off his creditors. Unless they can reach an amicable agreement about what to do, inheriting your home could create a rift between them, especially if your son decides to go to court in an effort to force a sale.
2. Set up a living trust
A living trust is a type of trust that you create while you are still alive. You also transfer to the trust the assets that you want controlled by the trust; this is called "funding the trust."
While you are alive, you can manage and benefit from those assets, just like you do now; but when you die, the assets get transferred to the beneficiaries you designated in your trust document.
Using a living trust rather than a will to transfer your home upon your death offers a number of advantages. One of them is that the home will pass to your designated beneficiary without having to go through probate, thus avoiding the delays and expenses associated with that process. As a result, your home can get transferred to that individual much more quickly. It's important to note, however, that any outstanding debts you may owe must still be paid before the transfer can happen.
A note of caution: If you set up a living trust, but do not transfer your house to it before you die, then the house will have to go through the probate before it can be transferred.
If you name more than one beneficiary for your home in your living trust document, you can avoid the potential for conflict among them about what to do with the house by stating in the document that the trustee of your trust -- a person or institution named to oversee the distribution of your assets and the payment of your debts after your death -- can decide who will get the house and who will receive other assets of equal value in your estate.
3. Include the right words in the deed to your home
Those words can be either "Transfer on Death" or "Joint Tenant with Right of Survivorship." ("Tenants by the Entireties" is another option between spouses in some states.) Either option lets you give your home to your loved one(s) at your death without the delays associated with probate or the cost of setting up a trust.
If you don't have a spouse, it's usually best to include the words "Transfer on Death" in the deed to your home, assuming a Transfer on Death deed is legal in your state. (Currently, about half of the states plus the District of Columbia recognize this kind of deed, but other states are considering it.) With a TOD, you own your home 100% while you are alive, and you're free to do whatever you want with it -- borrow against it or get a reverse mortgage, for example. When you die, the home automatically and immediately transfers to the person(s) you named as beneficiary in the deed.
If you include the words "Joint Tenant with Right of Survivorship" in your deed, you and whoever else is on the deed are co-owners of your home. When you die, assuming you die first, the house automatically transfers to your co-owner(s).
One of the drawbacks to this form of ownership is that you won't have full control over your home. For example, if you want to borrow against the house or refinance it, your co-owner might object and might even take you to court to stop you from doing what you want. Another drawback is that your home is subject to the debts of your co-owner. This means, for example, that if your co-owner is sued by a creditor for a past-due debt, the creditor might get the right to put a lien on the house.
Finally, Medicaid eligibility is something else you should take into account if you think you may need to apply for this federal government program at some point. If you do, including your home in your will rather than transferring it to a living trust is best. Again, consult with an estate planning attorney if Medicaid eligibility is a concern for you.
Making that decision yourself could be problematic, so it bears repeating: A qualified attorney can help you determine the best way to ensure that your home will go to your intended heir(s) when you die.

Wednesday, August 26, 2015

Tax and spin: Most families in Wisconsin, it turns out, would save on taxes by moving to Minnesota


On Tuesday, Scott Walker will bring his presidential campaign to Minnesota, where he’ll give a speech on the Affordable Care Act and attend a fundraiser. At those events, Walker will no doubt boast about his conservative record as governor of Wisconsin: an ambitious if sometimes polarizing set of public policies that have reduced government spending, curtailed collective bargaining rights and — as he is sure to remind people — reduced the state’s taxes by more than $2 billion.

Just as predictably, Walker is likely to be asked more than a few questions about the state where he’ll be holding forth, a place where his counterpart, Democratic Gov. Mark Dayton, has pursued the sort of agenda that might cause Walker to break out in hives: expanding union membership, increasing school funding and  — most notably — implementing a tax hike on the wealthiest Minnesotans.

Comparing the two states under the two men over the last few years has become something of a national sport, after all, a favorite pastime among journalists, academics and politicians alike. Even President Barack Obama has gotten in on the act. Before an audience in La Crosse last month, he paraphrased the local paper by saying that Minnesota was “winning this border battle” when it came to the states’ respective economic fortunes.

And yet, despite all the ink spilled about both Walker and Dayton and their records, almost all of the assessments overlook a longstanding but seldom-discussed fact about life on either side of the St. Croix River: that a majority Minnesotans actually pay a smaller share of their household income toward taxes than Wisconsinites.

The primacy of property taxes
How can that be the case?

In 2013, Walker delivered on one of his big campaign promises when the Wisconsin Legislature passed a bill that compressed five income tax brackets into four and lowered all rates, reducing the average rate from 6.4 percent to 5.9 percent.

That same year, Minnesota went in the opposite direction, with the Legislature passing a Dayton-led initiative to add a fourth state income bracket for individuals earning over $150,000 or couples earning over $250,000. The rate, of 9.85 percent, was among the highest in the country, and it meant the state’s average income tax rate would go from 6.8 percent to 7.5 percent.

But those high-profile changes only affected the income tax, not sales tax or, importantly, property tax — the key factor in comparing the overall tax burden between Minnesota and Wisconsin.

For years, Wisconsin has had some of the highest residential property taxes in the country. The result is that across every income bracket, homeowners in Wisconsin pay a higher share of their income to property taxes than those in Minnesota, according to data compiled by the Institute on Taxation & Economic Policy, a nonpartisan think tank that studies tax policy. To take just one example, the taxes on Walker’s $360,000 home in suburban Milwaukee County were more than $8,000 in 2014.

In fact, for all but the top earners, Wisconsin homeowners who work in Minnesota would often fare better by staying on this side of the river, largely because property tax rates are low enough to make up for higher income tax rates. As a report from the National Center for Policy Analysis noted last year: “While a renter would fare worse in Minnesota thanks to the higher income tax, homeowners would fare better because of Minnesota’s lower property tax rate.”

Walker didn’t create the higher property taxes, but he also hasn’t been able to do much about them, either. The reason lies in Wisconsin’s state constitution. Unlike Minnesota and all but seven other states, Wisconsin is required to tax all property equally, be it commercial or residential. That means Wisconsin can’t shift any of the tax burden from homeowners to owners of other types of property, as many states do (including Minnesota).

As a result, Wisconsin’s high property tax essentially wipes out any savings most taxpayers would see due to the lower income, sales and excise taxes compared to Minnesota. In fact, the only group that faces a higher tax burden in Minnesota than in Wisconsin are families with household incomes over $200,000.

Small businesses benefit
Just as the Wisconsin’s tax-code restrictions hurt homeowners compared to those in Minnesota, they help business, because they bear a smaller share of all property taxes in the state.

Small business owners in Wisconsin have another advantage over their counterparts in Minnesota: Because many small businesses are known as “pass-through entities” whose owners pay their corporate tax on their personal income tax form, they benefit from Wisconsin’s lower income tax rate vs. Minnesota’s.

Given all that, one might expect business to be flocking to Wisconsin. But two years after the states’ biggest tax changes took effect, there’s little evidence to suggest any such migration is happening.

David Ross, president and CEO of the Duluth Area Chamber of Commerce, says he doesn’t see businesses moving across the border to Superior, despite Wisconsin’s efforts.

That’s partly because moving a business can be risky, Ross said, if for no other reason than political ideology can change with each election. Instead, what’s reliable is a quality work force — the main incentive for businesses to locate in an area, he said, as is quality of life.

“All of these wild incentives from these different states are often from a state that is the least attractive,” Ross said. “The cost of government is certainly, within a state, an important factor to keep in mind. (But) people want to live in a community where there’s a strong public school system, where it’s a safe place to raise a family, where there’s strong recreation. I think those states that are focusing on cost of government are in a bad place. We’re promoting much more lifestyle and a place to live, not just a place to work. ... So I am not impressed with the position of Walker. We have done nothing other than become stronger, our state as an economic entity, since his election.”

Tuesday, August 25, 2015

Converting an IRA from a Tax Loser to a Tax Winner

We are all basically dealt the same cards in the tax game, but how we play them determines whether the IRS wins or we do. Sadly, most taxpayers play their IRA cards wrong, and the result is that their families lose. 
Almost all IRAs are “traditional” IRAs whereby the account holder receives a tax deduction for the funds he or she puts into them, and income taxes on profits and other gains are deferred until the funds are taken out of the account. All other qualified plans (401(k), profit-sharing and the like) can be rolled over into a traditional IRA.
As the owner of a traditional IRA, you must take required minimum distributions (RMDs) from your account every year, starting when you reach age 70½. These distributions are based on life expectancy tables, so the percentage of the account required to be withdrawn increases a bit each year. Because RMDs decrease as life expectancy increases—in other words, the younger the beneficiary, the lower the RMD—it is to your advantage to make someone younger than you the beneficiary of your IRA. Often, this person could be your spouse. But what if you make your children the beneficiaries of your IRA? Now the life expectancy tables make this minimum distribution amount so small that almost all of the IRA funds can grow—tax deferred—for another full generation. Make that for two generations if you leave all or some of your IRA to your grandchildren. Great tax planning! This is called a “stretch” IRA. (Do not make your estate or a trust the beneficiary of your IRA, as this eliminates the stretch-IRA option.) 
Commonly, IRA holders do make their spouses the primary beneficiary and, in case the spouse dies first, will make their children and/or grandchildren contingent beneficiaries. As the beneficiary:
1. The spouse can roll the IRA funds into his or her own IRA, pushing the RMD down the road to when he or she reaches age 70½ (assuming that the spouse is younger than the deceased).
2. The spouse can name new beneficiaries, most likely children or grandchildren.
3. The spouse may be able to convert the traditional IRA to a Roth IRA, which provides a huge tax advantage to the family’s younger generations. This conversion can take place all at once or over several years, if this option can help reduce income taxes. (There are key differences between traditional and Roth IRAs that any qualified tax advisor should be able to explain.)
The enemy of the traditional IRA is a possible double tax. There are always income taxes (both federal and state), and if the account holder’s overall estate is large enough, the estate-tax monster will get its bite as well. The average double-tax rate is a whopping 64 percent—$64,000 out of every $100,000 in the estate to the tax collector and only $36,000 to the family.
The typical reader of this column who calls me for tax help is a male owner or retired owner of a closely held business whose age may range from his late 40s to early 80s. Rarely does this person need the funds in his IRA to maintain his current lifestyle. What started out as a good idea early in his life—parking deductible contributions in a qualified plan—has turned into a lousy, tax-prone asset later in life.
What to do? The goal is simple: Turn the funds that are subject to double-tax in the investor’s IRA (or other qualified plans) into tax-fee dollars. This is easy to do if this person is insurable (and, if he is married, if his spouse is insurable as well). We typically use our trusty “Retirement Plan Rescue” (RPR). It’s a simple, four-step process:
Step 1. Purchase an annuity for the IRA. If the IRA already owns an annuity, this existing policy can be used in the following steps.
Step 2. Annuitize the annuity, converting it to a flow of guaranteed income into the IRA every year for as long as the investor or the spouse lives, depending on whether it is a single-life or second-to-die annuity.
Step 3. The IRA distributes an annuity amount annually, which is subject to income taxes. This distribution is often all or part of the RMD.
Step 4. Use this annuity distribution to pay the premiums on a new life insurance policy. This could be a single-life policy if the investor is not married or a second-to-die policy if he or she is.
The sooner the IRA owner implements this strategy the better, as premium costs rise each year and health issues that he encounters as he ages might lock him out of certain policies. 
In addition, insurance proceeds are income tax free, according to the Internal Revenue Code, and setting up an irrevocable life insurance trust will help avoid estate taxes as well.

Monday, August 24, 2015

Long-Term Capital Gains Tax Rates in 2015

Long-term capital gains result from selling a winning investment that you've held for longer than a year. To encourage people to invest for the long haul rather than trading in and out of the market, the tax rates on long-term capital gains are lower than they are for investments you hold for a year or less. Below, you'll find out what the long-term capital gains tax rates are for 2015 and a couple ways you can cushion the blow of this much-debated tax.
How to figure out your long-term capital gainsThe first step in calculating the tax from selling an investment is figuring out how much you earned in capital gains. In general, this is pretty simple: take what you paid for the investment -- also known as your cost basis -- and then subtract that from the proceeds you received when you sold it. If the number is positive, then you have a capital gain; if it's negative, then you have a capital loss.
Occasionally, figuring your capital gain is more complicated. Sometimes, a company will pay money to you as a return of capital, which doesn't get taxed as a dividend or other type of income but which does change your cost basis. That has an impact on how much in gains you realize when you do sell. Moreover, different rules apply if you receive an investment as a gift or as an inheritance. The IRS has more details on cost basis rules and more complex situations at its website here.
Calculating the taxOnce you know the amount of the gain, you need to know the tax rates that apply. Three different rates exist on long-term capital gains, and which one is right for you depends onwhat tax bracket you're in:
  • If you're in the 10% or 15% tax bracket for ordinary income, then your long-term capital gains rate is 0%.
  • If you're in the 25%, 28%, 33%, or 35% tax bracket, then your long-term capital gains rate is 15%.
  • If you're in the 39.6% tax bracket, then your long-term capital gains rate is 20%.
Those rates apply to federal taxes, but if your state has an income tax, you'll probably have to add on an additional amount there. Some states, such as California, make no distinction between long-term capital gains and other types of income in imposing taxes. Others, such as Massachusetts, have much lower rates for long-term capital gains than for short-term gains. Your particular tax rate will depend on your income level and the specific brackets that your state imposes. For a good overview, check out this article on state capital gains taxes.
3 other things to keep in mindIn addition to the above, there are a few things you should remember about long-term capital gains and the taxes you have to pay on them.
First, for high-income taxpayers, long-term capital gains do count as qualifying income for purposes of the 3.8% surtax on net investment income. This means that for single taxpayers making more than $200,000 and joint filers earning more than $250,000, the effective long-term capital gains tax rate is 3.8 percentage points higher than otherwise indicated.
Second, be aware that you only have to pay tax on the net amount of capital gains you have. So if you sell one stock at a gain and another at a loss, those two figures can balance each other out, and you'll only pay tax on the total amount of overall profit from the combination of both positions.
Finally, if you hold your assets until your death, then your heirs get an automatic step-up in cost basis. That effectively eliminates any pent-up capital gains tax liability and gives your heirs a fresh start. They'll pay taxes on any gains after your death, but for long-held winning stocks, the step-up at death is a huge tax break.
Tax planning can seem complex, but in some cases, it is. But dealing with capital gains doesn't have to be hard. Keep these simple tactics in mind, and you'll go a long way toward reducing your 2015 capital gains tax bill.

Sunday, August 23, 2015

Tax obligations as a business owner

When you start a business, a key to your success is knowing about your tax obligations. You may not only need to know about income tax rules, but also about payroll tax rules. Here are five IRS tax tips that can help you get your business off to a good start.

1. Business structure. The most common types of business structure are sole proprietor, partnership and corporation. The type of business you choose will determine which tax forms you will file.

2. Business taxes. There are four general types of business taxes. They are income tax, self-employment tax, employment tax and excise tax. In most cases, the types of tax your business pays depends on the type of business structure you set up. You may need to make estimated tax payments. You can use IRS Direct Pay to pay them. It’s fast, easy and secure.

3. Employer identification number. You probably need to get an EIN for federal tax purposes. If you do, you can apply for it online.

4. Accounting method. An accounting method is a set of rules that you use to determine when to report income and expenses. You must use a consistent method. The two that are most common are the cash and accrual methods. Under the cash method, you normally report income and deduct expenses in the year that you receive or pay them. Under the accrual method, you generally report income and deduct expenses in the year that you earn or incur them. This is true even if you receive the income or pay the expense in a later year.

5. Employee health care. The Small Business Health Care Tax Credit helps small businesses and tax-exempt organizations pay for health care coverage they offer their employees. A small employer is eligible for the credit if it has fewer than 25 employees who work full-time, or a combination of full-time and part-time. The maximum credit is 50 percent of premiums paid for small business employers and 35 percent of premiums paid for small tax-exempt employers, such as charities.

The employer shared responsibility provisions of the Affordable Care Act affect employers employing at least a certain number of employees (generally 50 full-time employees or a combination of full-time and part-time employees). These employers’ are called applicable large employers. ALEs must either offer minimum essential coverage that is “affordable” and that provides “minimum value” to their full-time employees (and their dependents), or potentially make an employer shared responsibility payment to the IRS. The vast majority of employers will fall below the ALE threshold number of employees and, therefore, will not be subject to the employer shared responsibility provisions.

Employers also have information reporting responsibilities regarding minimum essential coverage they offer or provide to their full-time employees. Employers must send reports to employees and to the IRS on new forms the IRS created for this purpose.

Saturday, August 22, 2015

‘Reasonable Compensation’ Can Be Sticky for a Small Business


Structuring your business as a corporation offers certain advantages — especially the protection you get from being held personally liable for the debts of the business. But it also brings tax complications. One of the biggest involves your own income from the company. If you work for your corporation, you generally must pay yourself a salary of an amount the IRS considers “reasonable compensation.”

Further, reasonable compensation is viewed differently depending on whether you form a regular corporation or a “Subchapter S” corporation, a specific type of corporation designed for small businesses.

Literally hundreds of U.S. Tax Court cases deal with reasonable compensation. In a nutshell, reasonable compensation is what you would get paid to do the same job anywhere else. For example, if you are a web designer and people in your business typically get paid $64,000 a year, then you would pay yourself at least $64,000 in compensation (assuming the business generated enough money to do so).

You may want to increase your compensation, however, because the more you pay yourself, the more you can put into retirement plans. For instance, you can start a Solo 401(k) and put up to $54,000 a year into it, but only based upon your compensation. After you reasonably compensate yourself, you can take a distribution of the remaining profit from your corporation. Unlike the salary you paid yourself as an employee of the company, this distribution is paid to you as a shareholder.

What’s ‘reasonable’ in an S corporation
S corporations don’t pay federal income tax; instead, all profits and losses flow to the shareholders, who report them on their personal tax returns. There, it is subject to income tax but not self-employment tax. Self-employment tax is simply a self-employed person’s Social Security and Medicare tax, and in most cases it is 15.3% of net income. If you operate a business as a sole proprietorship, meanwhile, you pay self-employment tax on all your net income. If you’re in a partnership, you pay self-employment tax on any guaranteed payments to yourself, as well as your share of the net income from the business.

Being taxed as an S corporation would seem to eliminate self-employment tax. However, if you work for your S corporation, you have to pay yourself reasonable compensation. For example, if your company makes a profit of $100,000, people in your line of work make an average of $64,000, and you pay yourself a salary of only $20,000 and take the rest as a distribution of profit, then you aren’t reasonably compensating yourself.

The effect in a C corporation
In a traditional corporation, known as a C corporation, reasonable compensation is completely different. C corporations pay federal corporate income taxes on their profits. If you, as the owner, take distributions of corporate profits, you pay tax on them, too, on your personal tax return. This is what is known as double taxation.

Even though a C corporation pays taxes while an “S-corp” does not, there are times when it makes more sense to operate as a C corporation. For instance, the highest personal tax bracket is 39.6%. If you’re in the 39.6% tax bracket, you might be better off operating as a C corporation, because the highest corporate tax bracket is 35%.

Additional considerations
In an S-corp, paying yourself too little in salary is a bad thing, because the IRS may see it as an attempt to duck self-employment taxes. In a C corporation, by contrast, paying yourself too much in salary can be a bad thing. Salary is a deduction against corporate income, so the IRS might say you’re trying to evade corporate income taxes by paying yourself a large salary. Using the same situation as before, if you’re in the web design business, you would still pay yourself a salary of $64,000. You can either pay yourself the remaining profit in a distribution or leave it in the business as retained earnings.

A potential problem with leaving the money in the corporation is that there’s also an “accumulated earnings tax” for C corporations — a penalty tax imposed on companies that the IRS believes are holding onto profits to avoid paying their shareholders taxable dividends. It is much smarter tax planning to pay less of a salary in a C corporation than it is in an S corporation. Money you receive in a salary from a C corporation will be taxed at a higher rate than dividends from the corporation, which for most people are taxed at no more than 15%.

As you can see, reasonable compensation is different depending on whether you operate as an S corporation or a C corporation. Before deciding which type of corporation you should be, talk to a tax accountant.

Thursday, August 20, 2015

Getting married? Understand how that changes your finances

When it comes to money, marriage changes things. From owning property to retirement planning and estate planning to paying income taxes, the rules are different—and largely more favorable. And now that the Supreme Court has paved the way for same-sex couples to marry, millions of additional Americans will now be able to receive the advantages heterosexual couples have enjoyed for years.

Like so much else in personal finance, though, you have to understand the rules in order to get the maximum benefit. Here’s a quick overview.

Take advantage of spousal and survivor Social Security benefits

One of the most significant financial advantages of marriage is that it makes you eligible for both spousal and survivor benefits from Social Security. As a married couple, you will each be eligible to collect either a Social Security benefit based on your own work record, or up to 50 percent of your spouse’s benefit, whichever is greater. In addition, as a widow or widower, each of you will be eligible to collect up to 100 percent of the other’s benefit. And should you divorce, you may still be eligible for benefits as an ex-spouse.

Also realize that there are a number of strategies that can increase your combined benefit with your spouse; be sure to take your time and weigh your options before either one of you files.

Think carefully about how you title your property

Whether you’re buying a new home or sharing an existing home, think carefully about how the property is registered. Unless both of your names are on the property, the unnamed partner is vulnerable in case of divorce or death. If you sell your home, a single person only gets a $250,000 capital gains exclusion; a married couple who owns the home jointly can exclude up to $500,000.

Another bright spot is that it is generally much easier for a married couple to qualify for a mortgage.

Benefit from favorable gift and estate tax provisions

You will be able to take advantage of the unlimited estate tax marital deduction. A married person can leave an unlimited amount of money to their spouse without paying any estate tax. In addition, the surviving spouse can use any unused portion of the deceased spouse’s lifetime estate tax exclusion upon his or her death. Under current law, this means that a married couple can pass on up to $10.86 million free of estate tax.

Revisit your life insurance needs. In light of potential estate tax savings, wealthy couples should reexamine their need for life insurance. That old policy may no longer be necessary.

Your gifts to each other won’t be subject to gift tax. Married couples can transfer an unlimited amount of property to each other free of any reporting responsibilities or gift tax.

You may want to form a trust. If you are blending two families, you may want to create a QTIP trust. That way a surviving spouse is granted a life interest in the trust property, but upon his or her death, the property passes to heirs selected by the first-to-die spouse.

Pay attention to income tax implications

You will be able to choose between filing a joint or separate income tax return. This doesn’t mean that your combined tax bill will go down; in fact, you may see it go up—especially if you both earn a substantial and similar amount of money. Some tax credits and deductions will only be available if you file jointly, but it’s a good idea to consult with an accountant to see which choice is best overall.

You won’t have to pay tax on a spousal insurance benefit. When an unmarried person includes a partner on their health insurance plan, that benefit is taxable. For married couples, it’s tax-free.

You will be able to defer distributions from an inherited IRA. If you inherit an IRA from your spouse, you can basically treat it as your own and postpone taking required minimum distributions until the year you turn 70 ½. This can potentially allow your assets to continue to grow tax-deferred until they are withdrawn.

Look into new ERISA benefits

If one of you participates in a qualified retirement plan through your employer, your spouse will be entitled to a number of benefits and protections. For example, your spouse is the automatic sole beneficiary of your retirement assets, and must consent in writing to waive this benefit. A spouse is also entitled to other benefits including health care coverage as well as protection under the family medical leave act.

Familiarize yourself with military and veteran benefits

As a military spouse, you may be eligible for a number of benefits including health care and family separation pay. Spouses of deceased veterans are also entitled to benefits such as health care, educational assistance, home loan guarantees, and pensions.

Explore federal employment benefits

The federal government provides a broad array of benefits to the spouses of its more than 22 million employees, including health, retirement and survivor benefits.

If marriage is on the horizon, congratulations! But before you tie the knot, I highly recommend that you explore the financial implications of marriage as you plan your finances as a couple. That way you’ll best be able to enjoy this next chapter of your life!

Wednesday, August 19, 2015

The back door to a Roth

For 2015, the combined contributions to all of your traditional and Roth IRAs cannot be more than $5,500 ($6,500 if age 50 or over) or the amount of your taxable earned income, whichever is less. Your contribution to a traditional IRA account is deductible subject to certain income limitations. If you are not covered by a retirement plan and your filing status is single, then there is no income limitation. If you are filing as married filing jointly, and your spouse is also not covered by a retirement plan at work, then there is no income limitation. If your spouse is covered, then your contribution is deductible if your Modified Adjusted Gross Income (MAGI) is less than $183,000, and your deduction is phased out between $183,000 and $193,000. If you are covered by a retirement plan at work and your filing status is single, you can deduct the full amount of your IRA contribution if your MAGI is under $61,000. Your deduction is phased out between $61,000 and $71,000. If you are covered by a retirement plan at work and your filing status is married filing jointly, then you can deduct up to the amount of your contribution limit if your MAGI is under $98,000 and your deduction is phased out between $98,000 and $118,000.
The $5,500 ($6,500 if age 50 or over) limits also apply to Roth IRA contributions. However, your Roth contribution might also be limited by your filing status and income. If your filing status is single, then your Roth contribution limit is phased out between $116,000 and $131,000. If you are filing as married filing jointly, your contribution limit is phased out between $183,000 and $193,000. Roth IRAs are desirable because the money will grow tax-deferred and can be withdrawn tax-free subject to withdrawal rules.
The “back door” Roth  is a way for taxpayers with incomes above the phase-out limits to make an annual contribution to a Roth IRA. If you are above the income limits you can contribute to your traditional IRA and then convert that contribution to a Roth by rolling it over to a Roth IRA. Despite what you might read elsewhere, the conversion may not be tax-free. If you have any pre-tax money in a traditional IRA account, then you must prorate the conversion amount by the ratio of taxable versus nontaxable money in all of your traditional IRA accounts to determine the taxable amount of the conversion. Taxpayers who want to employ this strategy should talk to their tax practitioner and follow IRS Roth conversion rules.

Tuesday, August 18, 2015

Business Transition Planning: How To Leave Your Company To Your Children


In my financial planning practice, I work with many clients who own closely held, private, companies. As many are nearing their retirement years, a big focus of our work is planning the exit strategy for their family business. While a lot of the discussion is technical (e.g., how to maximize the value, how can we best minimize tax), a good deal of what we discuss, at least initially, is centered on a discussion regarding if they should transfer it to their children and how.

There are numerous questions and issues to consider when thinking about selling or transferring your family business to outsiders or to children. In the interview below, I talk to Todd Angkatavanich, Esq., a partner of the international private client law firm WithersBergman LLP. He is a Regional Practice Group Leader of the firm’s U.S. Trusts, Estates & Charities group and co-leader of the firm’s Family Enterprise Group, which focuses on representing the successful family in business and investing.

Robert Pagliarini: “There are a lot of parents who have built successful businesses. They’ve put in long hours and have sacrificed a great deal. They are now at the point where they want to scale back and retire. Their concern is that they don’t know how best to transfer the business to their child or children in such a way as to minimize taxes or disrupt the business. Based on your experience, what are the first things parents should be thinking about?”

Todd Angkatavanich: ”That’s a great, and loaded, question!”

“The best starting point is to start with a “wish list” type of approach to start to frame the discussion: Before getting into the various planning and coordination issues, very broadly start by considering to whom and in what percentages would you like to transfer your interests? Often this is a question that the matriarch or patriarch has considered many times over the course of their children’s lifetimes as they have seen them develop and mature (or not). Once the threshold “wish list” question has been answered, then the more complicated issues of ‘how to do it’ come into play. This stage will typically require a nuanced discussion of the various overlapping issues that need to be harmonized.”

Pagliarini: “Yes, I’ve found that it works best when the initial discussion is about what the family ultimately wants. Too often they will jump into wanting to discuss the most tax advantageous transfers or how to structure the financing. I’ve found it helps to table the “how” and first focus on the ‘why’ and the ‘what.’”

“In working with several clients — some who transferred businesses to their children and others who sold to a third party — I’ve found clients can quickly be overwhelmed with all the options and decisions they must address. In fact, one phone call stands out.”

“My client was selling her business — a business that was in her family for four decades — to a third party. Although she had children that could take over, she didn’t want them to have to run the business. She didn’t want them to have the life she had. This was identified early on in the discussion. The “why” for selling was strong and personal.”

“The deal took many months and it took a lot of work. One afternoon she called me to vent about the buyer and all their due diligence requests. She said she was fed up with them and was going to stop the sale. We find that seller’s remorse is common. But I knew what inspired her to consider selling in the first place. I asked her if she wanted her kids to have to sacrifice like she did to run the company. A few moments of silence and then, “I get it.” A few weeks later the deal closed and she has never looked back since. The why is what allowed her to think long-term and move the deal forward.”

“Once they’ve had the ‘why’ discussion, what questions then should the family be asking if the owner wants to leave the company to his/her child or children?”

Angkatavanich: “It is important to understand that there is no absolute “right” or “wrong” answer as to the vehicle that should be used and often the business transfer and succession plan is a very bespoke thing. There are however different legal, tax and cash-flow pitfalls that must be carefully navigated regardless of what structure is decided upon; failure to properly navigate these issues can result in unexpected and potentially negative tax and non-tax implications.”

Pagliarini: “What are some of the vehicles parents of a closely held business might consider when selling or transferring their business to children?”

Angkatavanich: “Different vehicles are typically considered in order to effectuate the transfer of interests in a family business in a tax efficient manner.  These often include Grantor Retained Annuity Trusts (GRATs), sales to grantor trusts, partnerships or limited liability companies, preferred “freeze” partnerships, private annuities and Self-Cancelling Installment Notes (SCINs). Each of these techniques have relative pros and cons and relative risk and reward profiles.”

“For example, sometimes a particular plan may involve a combination of techniques depending upon the client and appetite for complexity, risk and uncertainty.  Regardless of the vehicle or vehicles used to structure the transfer, it is critical that the formalities of a particular transaction be respected after the transaction is closed to give it the best chance of being respected for gift and estate tax purposes.”

“Making sure that the right structure for the family is selected and is realistic requires consideration of issues that will broadly fall into different themes that should be considered together: legal, tax (both estate/gift and income tax), cash flow needs, control/management and family dynamics/expectations.”

Pagliarini: “Likewise, what are a few initial questions parents should consider before they sell or transfer a business to their children?”

Angkatavanich: “Some initial questions that should be considered ideally with the family advisors are:

How much of the business do I want to transfer now?  Do I transfer it to or for all of my children, or just some (for instance, only the ones working in the family business)? If not all children are to receive a share, are the non-participating children somehow “made whole” with some other gifts or arrangements? Or does the matriarch/patriarch intend to transfer the business only to those who have put “sweat equity” into the business? This basic architecture can vary dramatically depending upon the intention of the parents – there is no inherent “right” or “wrong” answer and it is very much a personal decision.

If the parent wants to benefit all children but not all are involved in the business, should some distinction between voting and non-voting shares be considered, or some different classes of shares? What are the legal and tax pitfalls to consider?
Should I transfer by shares “outright” to my children or should I create a trust for their benefit?  What is the more efficient and effective trusts structure to create? How will a trust be taxed to my children, and is it possible to create trusts to preserve and protect family assets for many generations beyond my children’s lives?

Are my children ready to get involved in management? If not, how do I get them introduced to the concept? Can I remain involved in the business and to what extent can I continue to have influence or control?

How can I structure the gift to my children to be most efficient from a tax and protection standpoint?
What are the tax and legal risks and relative pros and cons of different types of structures?
Once the transfer is “closed” am I done?  What kind on ongoing requirements/attention is required to make sure the transaction is effective?

How do I determine the value of the target shares? How are they treated for tax purposes? How does this value work with my gift tax exemption? Are valuation discounts or premium applicable in determining the fair market value of the particular interest?”

“Additionally, it is important to look ahead to make sure that the remaining interests that the parent has continued to own (for instance a percentage interest in the business) is properly coordinated in the event of the parent’s subsequent passing while still owning those interests (perhaps by way of a buy-sell agreement) and that a proper funding mechanism is in place and current.”

“As you can see Robert, the decision to pass the family business to the next generation family members, while a major decision, is just the beginning of the exercise but from that point the real fun begins.

Saturday, August 15, 2015

Estate Planning Isn't Just for the Rich

Estate planning for high-net-worth clients can be complex and intricate, aimed largely at reducing tax bills. But what about estate planning for everyone else?

Just because clients may have fewer digits in their total net worth, say advisors, doesn't mean that it's any less important for them to focus on how to successfully pass on the assets they do have.

"There's this myth that trusts and estates planning is just for the wealthy," says Merrill Lynch advisor Stephen Stabile. "That's just not true."

Clients whose wealth doesn't trigger estate taxes still need expert guidance on every other aspect of successful wealth transfer – wills, guardianships, executorships, powers of attorney and a range of health-related issues, including long-term care and disability planning.

"It's not just about tax minimization," says Stabile, senior vice president of the Hirsch Stabile Group in New York. "It's making sure that your finances are taken care of if you become incapacitated, or if there are health care decisions that you want carried out according to your wishes, even if you're not able to make those decisions."


In fact, clients with fewer assets may create more challenges for advisors because they, like their wealthier counterparts, generally want to pass assets on to their children but are likely to have more anxiety about whether they will have enough to support themselves before then.

When advisor Stewart Welch first discusses estate planning, he says he’s concerned about the same things for every client, regardless of their net worth. "I'm going to open by telling the client, 'Don't worry about estate taxes – we're going to talk about that later.' What I want to know about is you and the way you think – and I especially want to know a lot about your children," says Welch, founder of the Welch Group in Birmingham, Ala.

While there may be fewer assets in a non-HNW family, personality issues can be similar. Everyone wants to be heard, understood and treated fairly, says Arne Boudewyn, managing director of family dynamics and education at Wells Fargo's Abbot Downing group.

"While in ultra-high-net-worth families, the discussions may be around things like personal property and real estate, in a family with less net worth, it may be more about personal family effects, mom's jewelry and paintings, some prized family possessions," Boudewyn says. "Some of the issues are the same, but the flavor is different depending on the level of net worth."


Trusts are not just for the wealthy, say advisors and attorneys. "My recommendation is to not overlook the benefits of trusts," says trusts and estates lawyer and CPA Gideon Rothschild, who is chairman of the trusts and estates and asset protection practices at Moses & Singer in New York.

Trusts not only ensure that a client's wishes are followed but also can offer valuable asset protection in divorce cases, or from creditors.

Advisors can also tactfully step in when clients want to give more to heirs than they can afford, says Welch, who is also a co-author of "J.K. Lasser’sNew Rules for Estate, Retirement and Tax Planning."

"Most people are underfunded for retirement, so they're not in a great position to be making a lot of gifts," Welch says. "If you have $2 million saved, that might feel like a boatload of money. But you can't really be certain, because you don't know how long you’re going to live."

Welch says some people give too much money to their children. "That's where they get their pleasure," he says. "I've seen people who have significantly sacrificed in their own retirement in order to give money to children and grandchildren, in many cases in inappropriate ways."

Welch does what he can to properly advise such clients.

"It's their money – they can do whatever they want with it," he says. "But as advisors, it's our job to advise them of the stop, yield and caution signs."

Friday, August 14, 2015

The 4 Best Roth IRA Benefits


A Roth IRA can be an excellent way to save for retirement, and it has several benefits that you might not be aware of. For example, did you know that a Roth IRA can also be an effective tool to save for your childrens' college education? Or that a Roth can be a valuable part of your estate planning?
Here's what you need to know about these and some of the other best Roth IRA benefits.
1. The tax benefits can be excellent
The most obvious benefit of a Roth IRA is tax-free compounding: You don't have to pay taxes on any capital gains or dividends on your investments. On top of that, any qualified withdrawals you make during retirement are free from income tax.
It's worth mentioning that you get a similar tax benefit with a traditional IRA. In addition to tax-free capital gains and dividends, a traditional IRA gives you an up-front tax break, as you may be able to deduct your contributions from your taxable income. So the choice between the two account types comes down to whether you want your tax benefits now or in retirement.
One of the benefits of the Roth IRA's tax-free withdrawals is that they protect you from income tax raises. If you're still years or even decades from retirement, then there's a good chance you'll be in a higher tax bracket when you retire, so it may be best to invest through a Roth and forgo the up-front tax break. Federal income tax rates are historically low right now -- after all, the top tax rate was 70% as recently as 1981. Contributing to a Roth IRA could allow you to avoid paying higher taxes in the future.
2. No minimum or maximum age requirementsWhile a traditional IRA requires account owners to stop contributing and begin taking minimum distributions at age 70-1/2, a Roth IRA has no such mandates.
In fact, you are allowed to contribute to a Roth IRA so long as you have earned income, even if you're 100 years old and receive payments from a business you own. The same goes for minors with income. If you're 14 and work a summer job, then you can contribute to a Roth IRA as well, giving you the potential for many years of tax-free growth.
You're also not required to begin taking distributions from your Roth IRA at any particular age. If you don't need the money, you can leave it alone and enjoy additional years of tax-free compounding, which can have an enormous effect over the years.
Let's say you retire at age 70 with a $500,000 Roth IRA, but you don't need the money because your other retirement investments, such as your 401(k), provide enough income. If you leave your Roth IRA alone and it compounds at a conservative rate of 6% per year, then the account could be worth $1.2 million by the time you reach age 85. The fact that you never have to withdraw funds from a Roth IRA makes it an excellent vehicle for building an inheritance for your loved ones (more on that later).
3. Your can still use your money if you need it
My personal favorite Roth IRA benefit is that your money isn't as "tied up" as it is with other types of retirement accounts. Sure, all retirement plans -- 401(k)s, traditional IRAs, etc. -- have some provisions allowing you to make early withdrawals under certain circumstances, namely, financial hardship.
However, your Roth IRA contributions -- though not any investment gains -- can be withdrawn at any time and for any reason. If you have contributed $5,000 to a Roth IRA each year for 20 years, then you can access $100,000 of your savings whenever you need to. In a sense, your Roth IRA can be a retirement plan and an emergency fund in one.
There are also withdrawal provisions that let you access your investment gains early without a penalty. For example, you can withdraw gains to spend toward the purchase of your first home or to cover postsecondary education expenses.
For this reason, a Roth can also be an effective tool to save for your children's (or your own) college education. If you work a part-time job during high school, you could save your money in a Roth IRA, enjoy tax-free compounding for a few years, and then withdraw any money in your account tax-free once you're in college -- or leave any excess in the account to get a head start on retirement savings. Note that if your withdrawals include investment gains, you'll be responsible for paying income tax on the gains unless you're over age 59-1/2, so keep this in mind before choosing to withdraw more than your original contributions early.
4. Roth IRAs can be good for estate planning
A Roth IRA can also be an effective estate planning tool, as it can not only allow your money to grow tax-free for your entire life, but also let you leave tax-free income to your heirs.
Your heirs will be subject to minimum distributions based on their age beginning in the year after your death -- unlike the original account holder, the inheritor cannot let money in an inherited Roth IRA compound tax-free indefinitely.
The IRS publishes a list of "life expectancy factors" that are used to calculate the minimum distribution requirements. For example, let's say you inherit a $100,000 Roth IRA and you're 35 years old in the year following the owner's death. The life expectancy factor is 48.5 for a 35-year-old, so to calculate the annual distribution requirement, you would take the account balance and divide by this factor, resulting in a $2,061 required distribution. The following year, you would use the life expectancy factor for a 36-year-old, and so on.
Even with these requirements, a Roth IRA can be an effective way to "prepay" taxes for future generations. Plus, given that you owe no taxes on your Roth contributions, setting aside as much as possible in a Roth can reduce the size of your taxable estate.
The takeaway
This is by no means an exhaustive list, and there are many pros and cons to all types of retirement plans, so it pays to do extensive research before making a decision. Having said that, the Roth IRA is a unique retirement savings vehicle and could be an excellent part of your long-term financial planning.