MODULE 8 ACHIEVING TAX AND ESTATE PLANNING OBJECTIVES IN RETIREMENT Flashcards
COST BASIS
cost basis is the PRICE PAID FOR AN ASSET, adjusted by costs incurred in buying, selling or owning it
e.g. a client’s cost basis in a stock is the purchase price of the stock adjusted upward by commission expenses and any transfer taxes
TAXATION OF CAPITAL GAINS AND LOSSES
long term capital gains (LTCGs) and long term capital losses (LTCLs) are NETTED, as are short-term capital gains and losses
married couples filing jointly in 2020
- 0% LTCG gain rate ends at $80K of taxable income
- 15% LTCG gain rate goes from $80K to $496.6
- 20% LTCG gain rate from $496.6K+
- net STCG treated as ordinary income, taxed at taxpayer’s marginal income tax rate
- net capital loss is deductible only up to $3K per year against ordinary income w/ a carryforward of remaining losses to the following years
THREE METHODS OF DETERMINING BASIS IN A MUTUAL FUND
(1) FIFO - IRS assumes this method if taxpayer fails to choose another method; usually least advantageous for the taxpayer during bull market
(2) SPECIFIC IDENTIFICATION METHOD - investor communicates to MF company which shares, based on which purchase date, are being sold; most advantageous method for investor bc allows for gain/loss sale manipulation
(3) AVERAGE COST METHOD - cost of all shares are aggregated & divided by the number of shares held (most common method. provided by MF companies)
TAXATION OF ZERO-COUPON BONDS
no annual income received from “zeroes”, the annual increase in value is taxed to the investor each year (“phantom income”); not much different than taxation of reinvested dividends in a mutual fund
investor has a current liability w/o cash in hand to pay it
HOW ARE W/D’S FROM DEDUCTIBLE IRA’S NORMALLY TREATED FOR TAX PURPOSES?
a person who makes a w/d from an IRA must ask “what is my basis in the account?”
if after-tax $’s used (nondeductible IRA), the total of contributions represents the owner’s basis
distributions are partially a return of capital + partially interest income; the portion of w/d representing basis is tax-free
EXPLAIN ROTH IRA “BACK DOOR” STRATEGY
individuals who are prevented from making deductible contributions to a traditional IRA or Roth IRA due to their AGI have the option of making a nondeductible IRA contribution
there is no AGI limit on taxpayer’s eligibility to convert funds held by traditional IRA into a Roth IRA, individual can convert nondeductible IRA assets into a Roth IRA
individual must pay applicable income taxes on GAINS in the account in the year of conversion
existence of a deductible IRA complicates issue, as portion of deductible IRA will be treated as converted also
LIST EXCEPTIONS TO THE 10% EARLY W/D PENALTY ASSOCIATED WITH DISTRIBUTIONS FROM AN IRA
IRC SECTION 72(T) specifies distributions from IRAs taken before 59 1/2 generally will be subject to 10% early w/d penalty, exceptions are made for:
(1) death of IRA owner (inherited IRA assets)
(2) disability of IRA owner (must be permanently disabled)
(3) medical expenses in excess of 7.5% AGI (2020)
(4) medical insurance premiums while unemployment (must be receiving unemployment for a # of months)
(5) qualified higher education expenses - tuition, fees, books, supplies, and equipment; must be postsecondary, includes graduate level
(6) qualified first-time homebuyer - neither taxpayer nor spouse can have had ownership in a principal residence for a two-year period prior to the date of purchase or commencement of construction (up to $10K)
(7) qualified reservist distribution made to an individual who is a reservist or national guardsman called to active duty for a period of 180 days+ for an indefinite period
(8) disaster-related distributions (e.g. tornado)
(9) series of substantially equal periodic payments)
(10) up to $5,000 per parent for distributions taken after the birth or adoption
premature distribution rules also apply to qualified retirement plans, 403(b), and TSA distributions. it does NOT apply to 457s
EXPLAIN HOW RMD DISTRIBUTION RULES APPLY TO IRA’S
with IRAs, SEPs, & SIMPLE IRAs, distributions MUST BEGIN by April 1 of the year FOLLOWING the year in which the individual reaches age 72 in 2020 and later, regardless of whether they are working or not
EXPLAIN REQUIREMENTS FOR A “QUALIFIED” DISTRIBUTION FROM A ROTH IRA.
a distribution is qualified if:
(1) the distribution is made after age 59 & 1/2, death, or disability, or if it is made to a first-time homebuyer for the purchase of a home (max $10K), AND
(2) a five-year holding period has been met
unless both of these conditions are met, the distribution will be considered “nonqualified” and the earnings will be taxable, and possibly subject to premature distribution penalty
EXPLAIN HOW THE 5-YEAR CLOCK FOR ROTH IRA CONTRIBUTION WORKS
the 5 year clock starts on January 1st of the year for which the contribution is made. e.g. your client opens a Roth IRA and makes a deposit on April 15, 2022 for the 2021 tax year. the contribution is made for the 2021 tax year, so the clock would start on Jan 1, 2021. so even though the contribution itself is being made on 2022, the 2021 five year clock starts in 2021. any subsequent Roth IRA accounts would be on this initial clock - there is no new clock for each contribution
STATE THE ORDERING RULES ASSOCIATED W/ DISTRIBUTIONS FROM A ROTH IRA
nonqualified distributions from a Roth IRA are taxable and subject to ordering rules, which treat all amounts distributed as CONTRIBUTIONS FIRST and then as EARNINGS.
therefore, no portion of such a distribution is treated as ordinary income (aka taxable income) until the total of all prior distributions exceeds the total of all contributions
(1) RETURN OF CONTRIBUTIONS. principal is returned first, and there is no income tax or 10% penalty assessed on this portion
(2) RETURN OF CONVERSION AMOUNT. this will not be subject to income tax since it was taxed when converted; however, if the individual is under age 59 & 1/2 it may be subject to 10% early w/d penalty tax if the converted funds have not been in the Roth IRA for at least 5 years from the date of conversion
(3) RETURN OF EARNINGS. earnings come out last, and will not be taxed if it is a qualified distribution (age 59 & 1/2 and the 5-year holding period is met). if it is not qualified, there will be a 10% early w/d penalty and income tax (unless one of the exceptions are met)
the ability to tap contributions first, and thus avoid taxation, is a tremendous advantage with Roth IRAs
EXPLAIN THE TAXATION OF LUMP SUM OR PERIODIC DISTRIBUTIONS FROM A NONQUALIFIED (AFTER-TAX) ANNUITY
w/d’s from a nonqualified annuity come first from earnings/gains (LIFO). distributions are fully taxable as ordinary income until all of the gains have been withdrawn. the principal amount (original contribution) is then withdrawn and not subject to tax, as it’s after-tax money.
in addition, w/d’s from an annuity prior to 59 & 1/2 are generally subject to a 10% penalty on the taxable portion of the distribution
EXPLAIN TAXATION OF ANNUITY PAYMENTS FROM A NONQUALIFIED ANNUITY
once annuitized, each monthly payment is considered partially a return of principal and partially distribution of gain, so each payment is taxable to some extent. the amount of each payment that is subject to tax is proportional to the extent it represents gain vs. a return of principal
UNDER SECTION 121, WHAT AMOUNTS CAN A SINGLE PERSON OR MARRIED COUPLE (FILING JOINTLY) EXCLUDE FROM CAPITAL GAINS TAX ON THE SALE OF A PRIMARY RESIDENCE (IF ALL CONDITIONS ARE MET)?
- $250K in capital gains exclusion allowed for a qualified single taxpayer
- $500K for a married couple filing jointly
BRIEFLY DISCUSS THE RULES AND REQUIREMENTS FOR THE USE OF HOME SALE EXCLUSION
(1) taxpayers must have owned & lived in the home for at least 2 of the past 5 years before the sale
(2) partial exclusion is available if taxpayer does not meet 2 year use rule due to health, job or unforeseen circumstances
(3) in general, these exclusions may not be used more than once within a 2-year period
(4) no age limit for who can qualify for this exclusion
(5) a qualifying widow/widower (surviving spouse for filing purposes) may exclude up to the full $500K if the residence is sold not later than 2 yrs past the spouse’s death & the other requirements for the $500K exclusion are met
***the portion of gain attributable to noqualified use of residence may not be excluded
EXPLAIN THE RELATIONSHIP BETWEEN TAX-EXEMPT INCOME & THE TAXATION OF SOCIAL SECURITY BENEFITS
taxpayers who receive SS benefits & other income find that a portion of their SS benefits are includible in taxable income if a calculation puts their income over certain thresholds
ironically, tax-exempt income is one of the factors in that calculation (provisional income)
the more muni bond income retirees have, the more likely it is they’ll have to pay taxes on otherwise untaxed SS benefits
SS benefits may be fully nontaxable, or may be subject to taxation on up to 50-85% of the benefits received
IDENTIFY AT LEAST 3 WAYS IN WHICH ESTATE PLANNING CAN HELP CLIENTS MEET THEIR OBJECTIVES
(1) PROVIDE FOR THE FINANCIAL NEEDS OF SURVIVORS. the death benefit of life ins, for example, provides an immediate estate for a surviving spouse & children. in other cases, assets can be transferred into a trust established for their benefit
(2) ENSURE THAT PROPERTY IS DISTRIBUTED ACCORDING TO THEIR WISHES. a last will & testament, thoughtful naming of beneficiaries, and titling property in certain ways can direct property to intended recipients
(3) PROTECT ASSETS FROM BEING SEIZED BY CREDITORS. a trust where distributions are at the discretion of the trustee, that is irrevocable, and that contains a spendthrift clause can foil the attempts of creditors of both the grantor and trust benes to get @ trust assets
(4) AVOID THE COSTS AND DELAYS ASSOCIATED W/ PROBATE. assets transferred through the simple mechanism of a will are reduced through expenses and legal fees associated w/ probate & can take months to reach benes. various estate planning tools can be used to avoid this slow & often costly form of property distribution.
(5) MAKE PROVISION FOR INCAPACITY. illness, injury & old age can rob a client of the ability to manage their own affairs, including decisions on personal care, health care, and mgmt of finances/property. several legal instruments can be employed to deal w/ these possibilities: trusts, disability & LTC insurance, POA for health/property
(6) MINIMIZE TAXES. estates w values exceeding max applicable exclusion amt are subject to fed estate tax. state inheritance or estate taxes can kick in at even smaller amounts. good estate planning can reduce or eliminate these taxes, leaving more for inteded benefits.
(7) ENSURE ORDERLY SUCCESSION IN THE CLOSELY HELD OR FAMILY BUSINESS. estate planning tools can assist in the orderly transfer of ownership for small businesses.
DEFINE ESTATE
an estate is all the rights, titles, and interests that a person (living or dcsd) has in any property. an estate can include both tangible and intangible personal property and real property.
DEFINE ESTATE PLANNING
estate planning is an activity that arranges for the CONSERVATION and TRANSFER OF PROPERTY from one person to other persons/entities so as to achieve, as much as possible, the FIRST PERSON’S OBJECTIVES & MINIMIZE TAXES/TRANSFER COSTS
DESCRIBE THE DIFFERENCE BETWEEN A PERSON’S PROBATE ESTATE VS. GROSS ESTATE
probate estate - comprised of all assets that will be transferred @ the person’s death either by will or state laws of intestate succession.
gross estate - includes all assets that are subject to the federal estate tax @ person’s death
**everything in probate estate is included in gross estate; however, gross estate includes many assets not in probate estate. (probate estate is under the umbrella of gross estate)
DESCRIBE THE KINDS OF ACTIVITY THAT MUST BE AVOIDED BY A COUNSELOR WHO IS NOT ALSO AN ATTORNEY TO PREVENT UNAUTHORIZED PRACTICE OF LAW
a person who is not a licensed attorney in the state they’re giving advice can avoid the unauthorized practice of law by not drafting/interpreting legal docs and by not explaining/applying state law.
DEFINE WILL
a legally enforceable declaration of how an individual’s probate property is to be distributed when they die. wills are revocable until the time of death.
DEFINE PROBATE
a court-supervised process for ADMINISTERING & DISTRIBUTING property subject to a will or state laws of intestacy at a person’s death
DEFINE INTESTATE
dying without a will. a person who died w/o having first created a will is said to have “died intestate”
DEFINE PERSONAL REPRESENTATIVE
the generic term given to someone appointed by a court to administer a decedent’s estate
DEFINE EXECUTOR/EXECUTRIX
alternative names (male/female) given to a personal representative of decedent who died w/ valid will by some states
EXPLAIN THE DISADVANTAGES OF DISTRIBUTING PROPERTY THROUGH THE PROBATE PROCESS
(1) probate is a public process. the dcsd’s private financial affairs, creditors and debts, and ID of people receiving property will be on public record (perceived as a negative)
(2) probate court must ascertain the validity of the will, and personal rep must gather & identify the property of the dcsd’s estate, & carry out other time-consuming activities. this delays the xfer of the dcsd’s probate property to ultimate recipients
(3) various legal & admin costs are associated w/ probate. in most cases, the larger the estate, the higher the cost.
