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FALL 1999

Wink Tax Services

IN THIS ISSUE...     

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THE PATH LEADING TO YOUR GOALS

What are you doing to help ensure that you are making progress toward your financial goals? Developing and following a written financial plan will give you a road map to help you keep on track. The steps include:

1. ASSESS YOUR CURRENT FINANCIAL SITUATION.

This involves preparing a net worth statement and an analysis of how your income is spent. A net worth statement lists your assets and liabilities, with the difference representing your net worth. Periodically preparing a net worth statement will help you assess whether you are making progress toward your goals.

Even if you don't feel a need for a budget, you should analyze how your income is spent. The analysis can help you find ways to reduce spending and increase saving.

2. ESTABLISH WRITTEN, SPECIFIC FINANCIAL GOALS.

Your goals should be defined in specific, quantifiable terms, so you have a means to measure progress. Also attach a timetable to each goal. If you have several financial goals, you should prioritize them so you devote resources to those most important to you. The most common long-term objectives include:

  • Financial Independence (at retirement or sooner)
  • College education for children
  • Paying off debt
  • Supporting a desired lifestyle
  • Owing a business
  • Major charitable giving

3. DEVELOP A DETAILED PLAN, WITH SPECIFIC STRATEGIES AND TIMETABLES.

Your financial plan should coordinate strategies in several important areas:

 
bullet INVESTMENT STRATEGIES - Your investment strategy determines which investments should be utilized for your savings. Develop a strategy you are comfortable with, that takes into account a tolerable risk level and your time frame for investing.
bullet TAX PLANNING STRATEGIES - Strategies that help reduce income taxes can give you more funds for saving. While tax considerations should not be your sole consideration, they should be considered before implementing any options.
bulletDEBT STRATEGIES - While debt may be necessary to help you achieve some goals, such as purchasing a home, you should develop strategies to avoid incurring excessive amounts of debt.
  • RISK MANAGEMENT STRATEGIES - To ensure your plan won't be derailed by catastrophes, assess your life, health, disability property, and liability insurance.
  • ESTATE PLANNING STRATEGIES - Proper estate planning helps ensure that your wealth is distributed according to your wishes at a minimal estate tax cost.

4. IMPLEMENT YOUR FINANCIAL PLAN.

While a financial plan can be prepared in a short time period, implementing the plan requires a lifetime of discipline and dedication. Make saving and investing part of your monthly routine so they become strong habits. Don't become overwhelmed by the amounts you need to save, since it often takes years to see substantial progress toward your goals. Don't try to accomplish too much at once or you may become disillusioned with your entire plan. Strive to make slow and steady progress.

5. MONITOR YOUR PROGRESS.

At least annually, review your progress toward your goals:
  • Update your net worth statement and analysis of spending
  • Evaluate your investment performance. 
  • Rebalance your investments if changes are needed to maintain your desired asset mix. Note, portfolio rebalancing is a taxable event that may result in a taxable gain or loss.
  • Decide if any changes should be made to your financial goals.

Developing a financial plan is a complex process that requires coordination of all your finances. But the process can be well worth the effort, giving you a means to help achieve your financial goals. If you'd like help with your financial plan, just call.

TAX STRATEGIES FOR YOUR INVESTMENTS

Although you shouldn't make investment decisions solely for tax reasons, using proper strategies can help reduce your income taxes:

GENERAL

Carefully consider which investments to hold in tax-advantaged and taxable accounts. Gains from investments held in retirement accounts, such as 401(k) plans and traditional individual retirement accounts (IRAs), are taxed at ordinary income tax rates when withdrawn, rather than the lower capital gain tax rates. While it may make sense to hold investments that produce ordinary income in retirement accounts and investments that produce capital gains in taxable accounts, there are non-tax factors to consider, including your investment period.

Capital losses offset capital gains on a dollar-for-dollar basis, plus up to $3,000 of excess capital losses can be deducted against ordinary income. If you have excess capital losses above that amount, you can carry the loss forward or consider selling investments with gains to take advantage of the loss. You may also want to sell assets with a loss to offset large capital gains.

Use the proper basis when calculating gains from assets you inherited, which is generally the market value on the date the previous owner died.

STOCKS

Keep in mind that the capital gain tax rate on assets held for more than one year is now 20% (10% for taxpayers in the 15% tax bracket). That makes stocks seem more attractive than investments that generate ordinary income, but don't purchase stocks unless they fir in with your specific goals and you are willing to hold them for the long term.

Donate appreciated stock that you have held for over a year to a charity so you can deduct the fair market value. Not only will you get a charitable contribution deduction, but you avoid paying capital gain taxes on the gain. The deduction amount is subject to limitation, based on a percentage of your adjusted gross income.

If you are planning to make an annual gift of $10,000 ($20,000 if split with your spouse) to a child, consider gifting appreciated stock held long term. While your child retains your basis in the stock, he/she may only pay 10% capital gain tax if he /she is in the 15% tax bracket.

Take advantage of a stock loss, even if you think the stock has the potential to increase in value. First, purchase the same number of shares of the stock. Wait at least 31 days and then sell the original shares at a loss. You still own the same number of shares, but can deduct the loss on your on your tax return. You must wait at least 31 days before selling so that you can recognize the loss in the year of the sale for tax purposes.

Make sure to deduct reinvested dividends from your calculation of gains. You already paid ordinary income taxes on those dividends.

50% of the gain from the sale of qualified small business stock issued after August 10, 1993 and acquired at its original issue can be excluded if the stock was held for more than five years. There are limits on the amount of gain eligible for the exclusion.

Capital gains from the sale of publicly traded stock can be deferred if the proceeds are used to purchase an interest in a specialized small business investment company within 60 days. There are limits on the amount of gain eligible for deferral.

BONDS

Consider investing in municipal bonds since their interest income in most cases is exempt from federal income taxes and, possibly, state income taxes. First, consider the after-tax rate of return of municipal bonds and taxable bonds to see which is better suited for your situation.

If you have bonds that have declined in value, consider a tax swap, which involves selling those bonds and purchasing other, similar bonds. The loss can then be used to offset other capital gains. Be sure to follow the wash sale rules or your loss may not be deductible in the year of the sale.

Please call if you'd like help with your investment decisions.

RETIREMENT MYTHS AND REALITIES

Planning for retirement is a different process, made even more difficult by the large number of myths surrounding retirement. Some of the more common myths include:

MYTH: RETIREMENT WILL ONLY LAST A FEW YEARS. REALITY: Today, the average 65-year-old man will probably live another 15.6 years while the average woman will live another 19.2 years (Source: U.S. News & World Report, June 29, 1998). But those figures only represent average life expectancies, meaning half the population can expect to live longer than that. Plan on living at least age 90.

MYTH: ONLY 60% TO 80% OF PRE-RETIREMENT INCOME WILL BE NEEDED DURING RETIREMENT. REALITY: This may be true if you won't be very active during retirement, but more and more people expect retirement to include extensive travel and expensive hobbies. On the other hand, if you have several children who have just finished college and have just paid off your mortgage, you may be able to get by with even less than 60% to 80% of your pre-retirement income. Analyze your individual situation to determine how much you'll need.

MYTH: SOCIAL SECURITY AND PENSION PLAN BENEFITS WILL PROVIDE MOST OF YOUR RETIREMENT INCOME. REALITY: Even at current levels, Social Security benefits don't support a very lavish retirement. And many believe that changes will be made to the Social Security system that will likely reduce benefits. In addition, many companies are switching from traditional defined-benefit plans to defined-contribution plans, such as 401(k) plans, which require you to make contributions. Even those covered by a defined-benefit plan will find that most plans do not provide cost-of-living adjustments.

MYTH: YOU'LL STOP WORKING ENTIRELY WHEN YOU RETIRE. REALITY: For a variety of reasons, more and more retirees are taking on part-time employment, consulting assignments, or starting businesses. Keeping active both mentally and physically are major reasons, but work can also help from a financial standpoint.

MYTH: YOU CAN WAIT A FEW YEARS TO START SAVING FOR RETIREMENT. REALITY: The amounts needed to ensure a comfortable retirement can be huge. The sooner you start saving, the smaller the amounts needed to save.

MYTH: YOU ONLY NEED TO PLAN FOR YOU AND YOUR SPOUSE IN RETIREMENT. REALITY: Having started families later than past generations, many retirees may find that their children are still in college or could still be living at home. At the same time, aging parents may need financial assistance.

MYTH: YOUR HOME'S EQUITY CAN SUPPLEMENT RETIREMENT INCOME. REALITY: Unless you plan to sell your house and either rent or move to a smaller home, your home will probably not provide much in the way of additional income.

If you'd like help dealing with these realities, please call.

A LOOK AT EDUCATION IRAs

Wondering if you should utilize an Education IRA to help fund your child's college education? Before doing so, be aware of the restrictions involved:

  
bullet Annual contributions are limited to $500 per beneficiary under age 18. Although this is in addition to the $2,000 limit for other types of IRAs, many view the amount as too small. For example, if you invest $500 per year starting when your child is born, earning 8% annually, you could have $18,725 when your child turns 18. (This example is provided for illustrative purposes only and not intended to project the performance of any specific investment.)
bullet Although contributions aren't tax deductible, earnings on the contributions grow tax deferred until distribution. Earnings can be withdrawn tax free from when used to pay for qualified higher education expenses of the beneficiary. However, in any year that funds are withdrawn for this purpose, the taxpayer cannot use a Hope Scholarship Credit or a Lifetime Learning Credit.
bullet The Education IRA may be considered the child's asset for financial aid purposes, thus reducing the amount of financial aid received.
  • Eligibility to make contributions is phased out at adjusted gross income levels of $95,000 to $110,000 for single taxpayers and $150,000 to $160,000 for married taxpayers filing jointly.
  • Distributions must be made before the beneficiary turns 30. Any funds not used for qualified higher-education expenses are subject to normal income taxes and a 10% penalty. However, the balance can be rolled over to another Education IRA for another qualified family member, including the beneficiary's child, sibling, nephew, niece, certain in-laws, and their spouses.
  • Any year funds are put into a qualified state tuition plan, contributions can't be made to an Education IRA for the same child.

Despite these restrictions, you may still want to consider an Education IRA. In particular, those with incomes so high that they won't qualify for the Hope Scholarship Credit, Lifetime Learning Credit, or other financial aid should look into Education IRAs. If your income exceeds the limits for making contributions, you can ask grandparents or other relatives with income less than the limits to contribute for your children. Your child can also make contributions to his/her own Education IRA, since there is no earned income requirement for contributions. If you'd like to discuss whether you should use an Education IRA to help fund your child's college expenses, please call.

WHY YOU DON'T WANT A TAX REFUND

Aren't you excited to discover you will receive a tax refund? Most people are. However, what you may not realize is that government is giving you your money back interest free. In 1998, $114.3 billion in tax refunds were paid to taxpayers. Almost 70% of all individual taxpayers received refunds, with an average refund check of $1,365 (Source: Internal Revenue Service, 1999).

So, what can you do about this? To start, don't view your tax refund as a forced saving program. If you're concerned that you would just spend the difference each paycheck, you could have that amount automatically transferred to an investment account every pay period. (Remember that an automatic investing plan, such as dollar cost averaging, does not assure a profit or protect against a loss in declining markets. Because such a strategy involves periodic investment, consider your financial ability and willingness to continue purchases through periods of low price levels.)

If too much federal tax is being withheld from your paycheck, fill out a new W-4 to determine how many allowances you should claim. For 1999, every allowance exempts $2,750 of income withholding. Don't confuse allowances with the exemptions claimed on your tax return. You can claim additional allowances for items such as itemized deductions that exceed the standard deduction , the child tax credit, and education credits.

I know that taxes can be a confusing subject and it may be hard to believe you don't want a tax refund. If you have questions, please call.

AVOIDING TAX PENALTIES

No one likes to pay income taxes, but how would you like to pay penalties on top of those taxes? A large percentage of penalties result from improper payment of estimated taxes, so it is crucial to understand those rules.

Who pays estimated taxes? Estimated tax payments are required if your tax liability will be $1,000 or more than amounts withheld from your salary. Generally, individuals who receive significant income from sources not subject to withholding, such as dividends, interest, capital gains, self-employment income, rent, alimony, partnership interests , and S Corporation interests, must make estimated tax payments.

In 1999, individuals with adjusted gross income (AGI) over $150,000 in the preceding year must pay either 90% of the current year's tax liability or 105% of the prior year's tax liability. The 105% figure will become 106% for 2000 and 2001, changing to 112% in 2002, and 110% starting in 2003. Individuals with AGI not exceeding $150,000 must pay either 90% of the current tax year liability or 100% of the prior year's tax liability. These provisions allow individuals who cannot easily estimate their income before year end to avoid penalties by basing estimated tax payments on the prior year's tax liability.

Estimated tax payments are generally made in four equal installments on April 15, June 15, September 15, and January 15. However, if you don't receive income evenly throughout the year, you can make estimated tax payments based on actual income for the period. Be careful to pay the right amount with each installment - paying extra in later periods does not exempt you from penalties for under payments in earlier periods.

It is important to review your tax situation early in the year so you make proper estimated tax payments and avoid penalties. Please call if you'd like help evaluating your tax situation.

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We do not offer legal advice. All information provided on this website is for informational purposes only and is not a substitute for proper legal advice. If you have legal questions, we recommend that you seek the advice of legal professionals.

Tax Disclaimer: To ensure compliance with IRS Rules, any U.S. federal tax advice provided in this communication is not intended or written to be used, and it cannot be used by the recipient or any other taxpayer (i) for the purpose of avoiding tax penalties that may be imposed on the recipient or any other taxpayer under the Internal Revenue Code, or (ii) in promoting, marketing or recommending to another party a partnership or other entity, investment plan, arrangement or other transaction addressed herein.

Copyright 2017 Wink Tax Services / Wink Inc.
Last modified: January 30, 2017