The Perfect Gift? Ideas…From a Planning Perspective

December is here and 2016 is drawing to a close.  As we enter the holiday season, we scramble to pick the perfect gift for our family members, our friends, teachers… the list goes on.

At Parsec, we work with clients to create gifting strategies that fit into their overall financial plan.

This December we encourage you to think about giving and its potential longer term impact on both your family (children and grandchildren) and your taxes.  Let’s first review a powerful gifting strategy to younger family members: the custodial Roth IRA.

As long as there is earned income, which can come from mowing lawns, housework, babysitting etc., contributions to a custodial Roth IRA can be made up to the amount of the earned income but not over $5,500*.  For example, your 9 year old grandchild earned $1,000 over the summer through his lawn mowing business.  You can open a custodial Roth IRA for him and deposit a matching gift of $1,000. Let’s say he continues to mow lawns each summer for the next 10 years and you continue to match his earnings with a $1,000 holiday gift.  Assuming a 7% return each year, your gifts will grow to over $15,000 at the end of 10 years.  Remember this is only the beginning, the approximate $5,000 earnings in this example will continue to compound over time and ALL earnings are tax free upon withdrawal later in life.  Rewarding your grandchild’s hard work through Roth contributions is a holiday gift that offers valuable lessons on many levels.

Let’s switch gears to philanthropy.  Each year Parsec’s client service team processes hundreds of charitable gift requests from our clients.  These gifts of course offer tax advantages in various forms.  For many of our clients, the qualified charitable distribution or QCD brings the most formidable tax savings.  How does it work?  If you are over 70 1/2, up to $100,000 of your required minimum distribution (RMD) can be given directly to charity through a QCD.  The result: your AGI will be reduced dollar for dollar by the amount of the QCD.  A simple, yet impactful strategy:  on not only your charity of choice but also on your tax dollar.

As we enter this holiday season we hope that you reach out to your financial advisor to talk about gifting strategies that may be appropriate for you and your family.  Happy Holidays!

Betsy Cunagin, CFP®

Senior Financial Advisor

*$5,500 is the IRA contribution limit for 2016 and 2017.  

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2015 IRA Contribution Rules

The deadline to make IRA contributions for tax year 2015 is April, 15 2016. The maximum contribution is $5,500 per individual ($6,500 if age 50 or over) or 100 percent of earned income, whichever is less.

There are income limits which determine whether you can deduct your Traditional IRA contribution or if you qualify to make a Roth contribution. The following table gives the phase-out range for the most common circumstances.

Do you qualify to deduct your Traditional IRA contribution?
If your income is less than the beginning of the phase-out range, you qualify. If your income is over the phase-out range, you do not. If your income falls inside the range, you partially qualify.

Modified Adjusted Gross Income Phase-Out Range

Tax Filing Status For 2015 Contributions For 2016 Contributions
Single, participates in an employer-sponsored retirement plan: $61,000 – $71,000 $61,000 – $71,000
Married filing jointly, participates in an employer-sponsored retirement plan: $98,000 – $118,000 $98,000 – $118,000
Married filing jointly, your spouse participates in an employer-sponsored retirement plan, but you do not: $183,000 – $193,000 $184,000 – $194,000

Do you qualify to contribute to a Roth IRA for 2015?

Modified Adjusted Gross Income Phase-Out Range – Roth

Tax Filing Status For 2015 Contributions For 2016 Contributions
Single: $116,000-$131,000 $117,000-$132,000
Married, filing jointly: $183,000-$193,000 $184,000-$194,000

If your filing status differs from those listed above, please contact your advisor and he or she can help you determine whether you qualify.

Harli Palme, CFA, CFP®
Partner

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Taxable Income Reduction Strategies

As a trusted financial advisors for our clients, our priority is to stay apprised on current tax laws, as well as provide planning opportunities to reduce future tax liabilities. For many of our clients, their Traditional IRAs are also their largest tax liability. When an IRA is responsibly managed, the hope is that the account will continue growing until the owner’s late 70s. At that point in time, the mandatory withdrawals from the account may offset any capital appreciation and earnings on the account. When taking into account these growth expectations, as well as the client’s necessary cash flow, many clients find that the RMDs in their 80s will far exceed their necessary cash flow. These factors contribute to an increasing likelihood of the client having a higher tax rate later in life. Higher Modified Adjusted Gross Income(MAGI) is one concern that has a trickle down effect. When MAGI gets high enough, it can result in an income based adjustment for Medicare Part B and D. It should be clear by now that a healthy retirement can actually increase tax concerns.

So, by now you may be saying, “Thanks for the depressing news Daniel, I don’t think I want to read any further. ” I encourage you to keep reading.
 
Controlling Income

The first step in keeping MAGI low is controlling income. For retired individuals, there are two main sources of cash flow. The first being social security and pensions. These are fixed amounts that cannot be changed. The second source is income from personal assets. This includes brokerage accounts, Traditional IRAs, and Roth IRAs. A brokerage account is not a tax-deferred account. Therefore any income produced by the account will contribute to MAGI. It is possible to manipulate a brokerage account’s holdings to reduce taxable income. The second source of cash flow is withdrawals made from Traditional IRAs to supplement income or fulfill an RMD. These withdrawals are fully taxable to the individual. In addition to Traditional IRA withdrawals, Roth IRA withdrawals can be made, however, these withdrawals are not taxable to the individual if made after 59 ½. The IRS gives us tax tables, from these, we are able to determine the maximum amount of taxable income we want to produce for clients. As I said before, it may become impossible to keep income below this desired threshold when RMDs get larger and larger. If this is the case, we move on to advanced planning techniques.

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Roth Conversions and Charitable Remainder Trusts 
One of our favorite techniques to reduce the impact of RMDs is to combine the benefits of a Roth IRA with a charitable gift. The establishment of a Charitable Remainder Trust may allow someone with charitable intentions for their estate to realize the benefit now. The Charitable Remainder Trust can provide a lifetime income stream for the donor, as well as provide a large charitable deduction. In this tandem planning technique, the charitable deduction can offset the income incurred from a Traditional to Roth conversion. The reduction in the size of the Traditional IRA will also truncate the amount of the RMD going forward.
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This particular technique is just an example of some of the advanced planning options we evaluate with our clients. Every situation is different with special circumstances to consider. If you have any questions about these strategies, contact one of our advisors.
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