When it comes to saving for retirement, many Americans are playing catch-up. If you—or a relative—are among them, here is some good news: The belt-tightening required may not be as painful as you might think, provided you are willing to delay retirement for a few years.
According to a new study by the Center for Retirement Research at Boston College, a 45-year-old with no savings who earns $43,000 a year—the nation's average wage—would have to set aside about 18% of pay annually to maintain his or her current standard of living in retirement. (The math assumes a 4% return on savings.)
Such a target isn't much higher than the 12% to 15% annual savings rate many financial advisers recommend for clients in their 20s.
There is a catch, though: In order to maintain his or her standard of living in retirement, the 45-year-old must continue to work until age 70. In contrast, a 25-year-old who consistently saves 15% per year is likely to be able to afford to retire by age 65.
Part of the explanation has to do with Social Security. By putting off retirement until age 70, an individual would receive a benefit that is 75% higher than what he or she could claim at age 62, the earliest date of eligibility. Postponing retirement also gives 401(k)s and other retirement savings accounts additional years to grow. And it shortens the amount of time a nest egg must last.
To make it easier to meet your target savings rate, take advantage of any matching contributions your employer offers in a 401(k) or other workplace retirement plan.
And beware of shortcuts. In a bid to boost retirement savings, some may be inclined to ramp up exposure to equities, in the hope of earning a higher return over time. But such a move will expose them to greater downside risk—without delivering much additional retirement security should stocks fare well.
According to Boston College, a 35-year-old who sets aside 18% of his or her pay and earns a 4% rate of return will be able to retire at age 67; a 6% rate of return lowers the age to approximately 65.
Tuesday, November 22, 2011
Tuesday, November 15, 2011
12 Year-end Tax Planning Tips for Businesses and Individuals
Managing a tax burden has never been more difficult, whether you’re managing your individual tax rates, the rates on your investments, the taxes on your privately held or pass-through business, or the income of executives and shareholders at your company. Lawmakers have been aggressively using the tax code to try to get the economy back on track, and there are now more ways than ever to reduce your tax liability – however, all of them take planning.
Fortunately, there’s still plenty of time to put last-minute planning techniques into play. But remember to consider your individual circumstances and consult a tax adviser. With that in mind, Grant Thornton offers the following 12 last-minute tax planning tips for individuals and businesses owners:
Accelerate deductions and defer income.
Why pay tax now when you can pay tomorrow? Deferring tax is a cornerstone of tax planning. Generally this means you want to accelerate deductions into the current year and defer income into next year. There are plenty of income items and expenses you may be able to control, and business owners and self-employed taxpayers often have the best opportunities. Consider deferring bonuses, consulting income or self-employment income. On the deduction side, you may be able to accelerate state and local income taxes, interest payments and real estate taxes. But beware of the alternative minimum tax, which can affect timing strategies.
Bunch itemized deductions.
Many expenses can be deducted only if they exceed a certain percentage of your adjusted gross income (AGI). Bunching itemized deductible expenses into one year can help you get over these AGI floors. Consider scheduling your non-urgent medical procedures all in one year to clear the 7.5 percent AGI floor for medical expenses. To overcome the 2 percent AGI floor for miscellaneous expenses, bunch your pass-through business’s professional fees such as legal advice and tax planning, plus any unreimbursed business expenses such as travel and vehicle costs.
Maximize “above-the-line” deductions.
Above-the-line deductions are especially valuable because they reduce your AGI, and AGI is used to test whether you’re eligible for many tax benefits. Common above-the-line deductions include traditional Individual Retirement Account (IRA) and Health Savings Account (HSA) contributions, moving expenses, self-employed health insurance costs, alimony payments and any bank penalties you may have had to pay for early account withdrawals.
Consider charitable contributions carefully.
Think about giving appreciated property to charity so you can deduct the full value without paying capital gains taxes. But don’t donate depreciated property. Sell it first and give the proceeds to charity so you can take the capital loss and a charitable deduction. If you’re 70½ or older, consider making charitable donations directly from any traditional IRA distributions so the gift/distribution will not be included in your AGI. This provision is scheduled to expire at the end of this year. As always, double-check the limits and substantiation rules before making any contributions.
Leverage retirement account tax savings.
It’s not too late to maximize contributions to a retirement account. Traditional retirement accounts like 401(k)s and IRAs still offer some of the best tax savings in the tax code. Contributions reduce taxable income at the time you make them, and you don’t pay taxes until you take the money out at retirement. The 2011 contribution limits are $16,500 for a 401(k) and $5,000 for an IRA (not including catch-up contributions for those 50 and older). Remember that 2011 contributions to your IRA can be made as late as April 15, 2012.
Roll over into a Roth account.
“Roth” versions of traditional retirement accounts, such as 401(k)s and IRAs, also provide a great savings opportunity. You don’t get a tax break when you put money into a Roth account, but the money grows tax-free and is never taxed again if distributions are made properly. Rolling over into a Roth account now may make sense. Tax rates are low, and the value of many accounts has been artificially depressed by the economic downturn. Paying tax on the rollover now could save you if tax rates go up and your account recovers. The $100,000 AGI limit on these rollovers was recently lifted, so even high-income taxpayers can convert. Understand that you will be required to pay tax on the converted amount and plan accordingly.
Expense business investments
Business owners have been given a great opportunity to save on taxes while investing in their businesses this year. Legislation enacted in 2010 doubles a bonus depreciation tax benefit for property a business places in service before the end of the year. Under this provision, you can fully deduct the cost of eligible equipment on this year’s return if you place the equipment in service by Dec. 31. To qualify for bonus depreciation, the property you place in service must be new and generally have a useful life of 20 years or less under the modified accelerated cost recovery system (MACRS).
Consider your salary as corporate employee-shareholder
If you own a corporation and work in the business, you need to think carefully about your salary structure. Your tax treatment will vary depending on whether you’re organized as a traditional C corporation or an S corporation (in which corporation income is “passed through” and taxed at the individual level). Distributions of corporate income are generally not subject to Medicare tax. That means if your business is an S corporation, you will pay Medicare tax only on business income received as salary, not income received as a distribution. C corporation distributions also escape Medicare tax, but are subject to a 15 percent dividend tax rate. So many C corporation owners will pay less overall tax on income received as salary (which is deducible at the corporate level), while S corporation owners will do better with more income received as dividends. But remember to tread carefully. You must take a reasonable salary to avoid potential back taxes and penalties, and the IRS is cracking down on misclassification of corporate payments to shareholder-employees.
Make up a tax shortfall with increased withholding.
Don’t forget that taxes are due throughout the year. Check your withholding and estimated tax payments now while you have time to fix a problem. If you’re in danger of an underpayment penalty, try to make up the shortfall through increased withholding on your salary or bonuses. A bigger estimated tax payment can still leave you exposed to penalties for previous quarters, while withholding is considered to have been paid ratably throughout the year. To avoid any penalties, the best action plan is to make sure you pay estimated taxes equal to 110 percent of your estimated tax liability.
Don’t forget to use annual gift tax exclusion.
If you may have to pay estate taxes eventually, consider establishing a gifting program for your children and grandchildren to take advantage of the annual gift tax exclusion. Gifts of up to $13,000 per donee ($26,000 for married couples) are generally excluded from gift tax in 2011 and will be removed from your estate, with no limit on the number of donees. In addition, tuition payments to an educational institution for the benefit of your children or grandchildren are excluded from gift tax.
Watch out for the “kiddie tax.”
The “kiddie tax,” which requires a portion of a child’s unearned income to be taxed at the parents’ marginal rate, has been expanded to apply to full-time students under the age of 24 whose earned income does not represent at least one-half of their support. Be careful transferring income-producing assets to your kids.
Perform an overall financial checkup.
The end of the year is always a good time to assess your current financial situation and your plans for yourself and your business. You should think about cash flow, health care, retirement, investment and estate planning. Check wills, powers of attorney and health care proxies for changes that may have occurred during the year. Use the open enrollment period to reconsider employer-sponsored programs that could reduce next year’s taxable income. HSAs and flexible spending accounts for dependent care or medical expenses allow you to use pre-tax dollars. Remember, it’s never too early or too late to start planning for the future!
Keep in mind that these tax tips are general tax advice and may not be applicable to your particular circumstances. Make sure that you consult with your personal tax adviser before implementing any changes or additions to your tax planning strategy.
Fortunately, there’s still plenty of time to put last-minute planning techniques into play. But remember to consider your individual circumstances and consult a tax adviser. With that in mind, Grant Thornton offers the following 12 last-minute tax planning tips for individuals and businesses owners:
Accelerate deductions and defer income.
Why pay tax now when you can pay tomorrow? Deferring tax is a cornerstone of tax planning. Generally this means you want to accelerate deductions into the current year and defer income into next year. There are plenty of income items and expenses you may be able to control, and business owners and self-employed taxpayers often have the best opportunities. Consider deferring bonuses, consulting income or self-employment income. On the deduction side, you may be able to accelerate state and local income taxes, interest payments and real estate taxes. But beware of the alternative minimum tax, which can affect timing strategies.
Bunch itemized deductions.
Many expenses can be deducted only if they exceed a certain percentage of your adjusted gross income (AGI). Bunching itemized deductible expenses into one year can help you get over these AGI floors. Consider scheduling your non-urgent medical procedures all in one year to clear the 7.5 percent AGI floor for medical expenses. To overcome the 2 percent AGI floor for miscellaneous expenses, bunch your pass-through business’s professional fees such as legal advice and tax planning, plus any unreimbursed business expenses such as travel and vehicle costs.
Maximize “above-the-line” deductions.
Above-the-line deductions are especially valuable because they reduce your AGI, and AGI is used to test whether you’re eligible for many tax benefits. Common above-the-line deductions include traditional Individual Retirement Account (IRA) and Health Savings Account (HSA) contributions, moving expenses, self-employed health insurance costs, alimony payments and any bank penalties you may have had to pay for early account withdrawals.
Consider charitable contributions carefully.
Think about giving appreciated property to charity so you can deduct the full value without paying capital gains taxes. But don’t donate depreciated property. Sell it first and give the proceeds to charity so you can take the capital loss and a charitable deduction. If you’re 70½ or older, consider making charitable donations directly from any traditional IRA distributions so the gift/distribution will not be included in your AGI. This provision is scheduled to expire at the end of this year. As always, double-check the limits and substantiation rules before making any contributions.
Leverage retirement account tax savings.
It’s not too late to maximize contributions to a retirement account. Traditional retirement accounts like 401(k)s and IRAs still offer some of the best tax savings in the tax code. Contributions reduce taxable income at the time you make them, and you don’t pay taxes until you take the money out at retirement. The 2011 contribution limits are $16,500 for a 401(k) and $5,000 for an IRA (not including catch-up contributions for those 50 and older). Remember that 2011 contributions to your IRA can be made as late as April 15, 2012.
Roll over into a Roth account.
“Roth” versions of traditional retirement accounts, such as 401(k)s and IRAs, also provide a great savings opportunity. You don’t get a tax break when you put money into a Roth account, but the money grows tax-free and is never taxed again if distributions are made properly. Rolling over into a Roth account now may make sense. Tax rates are low, and the value of many accounts has been artificially depressed by the economic downturn. Paying tax on the rollover now could save you if tax rates go up and your account recovers. The $100,000 AGI limit on these rollovers was recently lifted, so even high-income taxpayers can convert. Understand that you will be required to pay tax on the converted amount and plan accordingly.
Expense business investments
Business owners have been given a great opportunity to save on taxes while investing in their businesses this year. Legislation enacted in 2010 doubles a bonus depreciation tax benefit for property a business places in service before the end of the year. Under this provision, you can fully deduct the cost of eligible equipment on this year’s return if you place the equipment in service by Dec. 31. To qualify for bonus depreciation, the property you place in service must be new and generally have a useful life of 20 years or less under the modified accelerated cost recovery system (MACRS).
Consider your salary as corporate employee-shareholder
If you own a corporation and work in the business, you need to think carefully about your salary structure. Your tax treatment will vary depending on whether you’re organized as a traditional C corporation or an S corporation (in which corporation income is “passed through” and taxed at the individual level). Distributions of corporate income are generally not subject to Medicare tax. That means if your business is an S corporation, you will pay Medicare tax only on business income received as salary, not income received as a distribution. C corporation distributions also escape Medicare tax, but are subject to a 15 percent dividend tax rate. So many C corporation owners will pay less overall tax on income received as salary (which is deducible at the corporate level), while S corporation owners will do better with more income received as dividends. But remember to tread carefully. You must take a reasonable salary to avoid potential back taxes and penalties, and the IRS is cracking down on misclassification of corporate payments to shareholder-employees.
Make up a tax shortfall with increased withholding.
Don’t forget that taxes are due throughout the year. Check your withholding and estimated tax payments now while you have time to fix a problem. If you’re in danger of an underpayment penalty, try to make up the shortfall through increased withholding on your salary or bonuses. A bigger estimated tax payment can still leave you exposed to penalties for previous quarters, while withholding is considered to have been paid ratably throughout the year. To avoid any penalties, the best action plan is to make sure you pay estimated taxes equal to 110 percent of your estimated tax liability.
Don’t forget to use annual gift tax exclusion.
If you may have to pay estate taxes eventually, consider establishing a gifting program for your children and grandchildren to take advantage of the annual gift tax exclusion. Gifts of up to $13,000 per donee ($26,000 for married couples) are generally excluded from gift tax in 2011 and will be removed from your estate, with no limit on the number of donees. In addition, tuition payments to an educational institution for the benefit of your children or grandchildren are excluded from gift tax.
Watch out for the “kiddie tax.”
The “kiddie tax,” which requires a portion of a child’s unearned income to be taxed at the parents’ marginal rate, has been expanded to apply to full-time students under the age of 24 whose earned income does not represent at least one-half of their support. Be careful transferring income-producing assets to your kids.
Perform an overall financial checkup.
The end of the year is always a good time to assess your current financial situation and your plans for yourself and your business. You should think about cash flow, health care, retirement, investment and estate planning. Check wills, powers of attorney and health care proxies for changes that may have occurred during the year. Use the open enrollment period to reconsider employer-sponsored programs that could reduce next year’s taxable income. HSAs and flexible spending accounts for dependent care or medical expenses allow you to use pre-tax dollars. Remember, it’s never too early or too late to start planning for the future!
Keep in mind that these tax tips are general tax advice and may not be applicable to your particular circumstances. Make sure that you consult with your personal tax adviser before implementing any changes or additions to your tax planning strategy.
Tuesday, November 8, 2011
Should Your Clients Have Children Pay for Stock in the Family Business?
Three strategies ensure how they can learn to earn and appreciate stock gifts.
Many parents who are business owners struggle not only with whether they want their children to take on ownership of the family business, but also with how to best transfer their ownership. The two obvious options are to gift or sell stock to the next generation.
This decision can be complicated further due to the circumstances leading up to the point when the next generation is ready to take on ownership. For instance, if the parents have been required to pay for their interest in the business, they may feel it should work the same way for their children. Another factor is the children themselves, who may be more or less interested in or capable of assuming ownership. Child A may have demonstrated strong potential and been even more successful than their parents in terms of operating the family business profitably, while Children B and C are less than fully engaged in the family business and thus have a lower probability of success.
I have even seen parents with multiple children who have started or bought additional businesses that are more in line with their children’s individual interests. In other cases, parents have established separate but equal leadership roles for their children within the family business to try to keep their children engaged in the parents’ dream of making them second-generation entrepreneurs. All of these variables can have an impact on whether parents decide to sell or gift ownership to children.
Some thoughts or emotions that may enter into having a daughter or son pay for interest in the family business include:
•They will value it more if they pay for it;
•We need our children to pay for the stock in order to fund our retirement needs;
•Siblings and co-workers may more fairly view the ownership transition if those receiving ownership have to pay for it.
In terms of gifting ownership, the overriding emotion is the pleasure that gift-giving provides to both the giver and the receiver. However, considering that many successful entrepreneurs provide a higher standard of living for their children than they personally experienced, gifting stock may exacerbate parental concerns about providing excessively for their children. Typical concerns along these lines include worries about creating a generation that is too materialistic; that continually expects bigger and better things; that has lost a sense of gratitude and may even have developed a sense of entitlement and boastfulness that is offensive to others and damaging to personal and business relationships.
What’re the Best Tax and Economic Approach to Stock Transition?
The short answer is that gifting is hands down the best approach to transferring ownership to the next generation. In fact, this option became even more attractive for gifts in 2011 and 2012, as a result of changes made by the 2010 Tax Relief Act. For these particular years, individuals with substantial wealth can take advantage of the $5 million gift-tax exclusion and the generation-skipping tax exemption in passing stock along to children. With the value of many companies depressed as a result of the economic recession we have experienced, the $5 million exclusion goes a long way.
A quick example may help demonstrate why selling stock to family members is not a good economic decision. Suppose you decide to sell your business to a child for $2 million. The selling price is subject to a federal capital gains tax of 15 percent plus state-income tax (let’s assume that the state income tax at five percent and that you have little or no stock basis). Your child has to earn approximately $3.3 million (assuming they are in a 40 percent tax bracket) to have $2 million to pay for the stock. Additionally, at your death, your estate will need to pay approximately $0.934 million in estate tax. The math on this transaction is reflected below to clarify what your client, the parent, really gets from the sale:
Gross sales proceeds $2,000,000
Less: Capital gains tax (1) (400,000)
Less: Estate tax (2) (700,000)
Net Proceeds $900,000
1.Note that the top marginal federal rate on stock sales is scheduled to increase to 20 percent beginning January 1, 2013, which will increase this amount in the future
2.Note that the above example uses a marginal federal estate tax rate of 35 percent that applies for 2011 and 2012, however the rate is scheduled to revert to 55 percent in 2013
When coupled with the $1.2 million dollars of tax the child will pay to get the $2 million of gross proceeds paid to the parent(s), it’s clear that this is an all-around losing proposition. Not only are your client and their children out the dollars paid in taxes, but they will both have lost the time value of money on the tax dollars.
How to Ensure Children Appreciate Stock Gifts?
A key ingredient seems to be developing successor leaders that have a solid understanding of what it takes to be successful in business as well as having them bring some valuable experience to the business. Possible ways to have them “earn” their equity and not officially pay for it include:
•Requiring them to work outside the family business before they can officially enter (after completing their college degree in a field relevant to the family business.)
•Setting milestones of commitment and achievement through an individual development plan designed to guide their career and growth as leaders in the business over an extended period of time.
•Easing children into greater ownership over time, such as awarding them non-voting shares so they can learn how to handle the privileges and responsibilities of ownership.
Conclusion
Having a well-conceived succession plan will address both the financial and leadership development aspects of the business for all generations of the family. With solid planning, the shares the parent gifts will feel a lot more like shares that their children have “earned”.
Since not all family businesses are interested or able to pass on ownership to children, in an upcoming issue I will divulge how an employee stock ownership plan can be used as an
employee- and tax- favored vehicle to facilitate succession.
Many parents who are business owners struggle not only with whether they want their children to take on ownership of the family business, but also with how to best transfer their ownership. The two obvious options are to gift or sell stock to the next generation.
This decision can be complicated further due to the circumstances leading up to the point when the next generation is ready to take on ownership. For instance, if the parents have been required to pay for their interest in the business, they may feel it should work the same way for their children. Another factor is the children themselves, who may be more or less interested in or capable of assuming ownership. Child A may have demonstrated strong potential and been even more successful than their parents in terms of operating the family business profitably, while Children B and C are less than fully engaged in the family business and thus have a lower probability of success.
I have even seen parents with multiple children who have started or bought additional businesses that are more in line with their children’s individual interests. In other cases, parents have established separate but equal leadership roles for their children within the family business to try to keep their children engaged in the parents’ dream of making them second-generation entrepreneurs. All of these variables can have an impact on whether parents decide to sell or gift ownership to children.
Some thoughts or emotions that may enter into having a daughter or son pay for interest in the family business include:
•They will value it more if they pay for it;
•We need our children to pay for the stock in order to fund our retirement needs;
•Siblings and co-workers may more fairly view the ownership transition if those receiving ownership have to pay for it.
In terms of gifting ownership, the overriding emotion is the pleasure that gift-giving provides to both the giver and the receiver. However, considering that many successful entrepreneurs provide a higher standard of living for their children than they personally experienced, gifting stock may exacerbate parental concerns about providing excessively for their children. Typical concerns along these lines include worries about creating a generation that is too materialistic; that continually expects bigger and better things; that has lost a sense of gratitude and may even have developed a sense of entitlement and boastfulness that is offensive to others and damaging to personal and business relationships.
What’re the Best Tax and Economic Approach to Stock Transition?
The short answer is that gifting is hands down the best approach to transferring ownership to the next generation. In fact, this option became even more attractive for gifts in 2011 and 2012, as a result of changes made by the 2010 Tax Relief Act. For these particular years, individuals with substantial wealth can take advantage of the $5 million gift-tax exclusion and the generation-skipping tax exemption in passing stock along to children. With the value of many companies depressed as a result of the economic recession we have experienced, the $5 million exclusion goes a long way.
A quick example may help demonstrate why selling stock to family members is not a good economic decision. Suppose you decide to sell your business to a child for $2 million. The selling price is subject to a federal capital gains tax of 15 percent plus state-income tax (let’s assume that the state income tax at five percent and that you have little or no stock basis). Your child has to earn approximately $3.3 million (assuming they are in a 40 percent tax bracket) to have $2 million to pay for the stock. Additionally, at your death, your estate will need to pay approximately $0.934 million in estate tax. The math on this transaction is reflected below to clarify what your client, the parent, really gets from the sale:
Gross sales proceeds $2,000,000
Less: Capital gains tax (1) (400,000)
Less: Estate tax (2) (700,000)
Net Proceeds $900,000
1.Note that the top marginal federal rate on stock sales is scheduled to increase to 20 percent beginning January 1, 2013, which will increase this amount in the future
2.Note that the above example uses a marginal federal estate tax rate of 35 percent that applies for 2011 and 2012, however the rate is scheduled to revert to 55 percent in 2013
When coupled with the $1.2 million dollars of tax the child will pay to get the $2 million of gross proceeds paid to the parent(s), it’s clear that this is an all-around losing proposition. Not only are your client and their children out the dollars paid in taxes, but they will both have lost the time value of money on the tax dollars.
How to Ensure Children Appreciate Stock Gifts?
A key ingredient seems to be developing successor leaders that have a solid understanding of what it takes to be successful in business as well as having them bring some valuable experience to the business. Possible ways to have them “earn” their equity and not officially pay for it include:
•Requiring them to work outside the family business before they can officially enter (after completing their college degree in a field relevant to the family business.)
•Setting milestones of commitment and achievement through an individual development plan designed to guide their career and growth as leaders in the business over an extended period of time.
•Easing children into greater ownership over time, such as awarding them non-voting shares so they can learn how to handle the privileges and responsibilities of ownership.
Conclusion
Having a well-conceived succession plan will address both the financial and leadership development aspects of the business for all generations of the family. With solid planning, the shares the parent gifts will feel a lot more like shares that their children have “earned”.
Since not all family businesses are interested or able to pass on ownership to children, in an upcoming issue I will divulge how an employee stock ownership plan can be used as an
employee- and tax- favored vehicle to facilitate succession.
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