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Jump-Starting Year-End Planning

With new tax laws in place for 2018, it’s a smart idea to get a head start on year-end planning, while you can still make tax-saving moves.  What are some issues to consider?

Estimate your income — Single taxpayers jump from the 24% tax bracket to the 32% bracket when taxable income reaches $157,500; for couples, it’s at taxable income of $315,000.  The top 37% bracket affects those with taxable income of $500,000 or $600,000 respectively.

Take advantage of retirement plans — Make contributions to IRAs and 401(k)s.  The 2018 contribution limits are $5,500 for IRAs, with an extra $1,000 catch-up amount for those age 50 or older, and $18,500 for 401(k) plans, plus an additional $6,000 catch-up amount.

Watch capital gains and losses — Most taxpayers pay long-term capital gains tax of 15% on the sale of appreciated assets, although higher-income individuals pay 20% and some may owe an additional 3.8% on net-investment income (e.g., capital gains, dividends, interest).  Taxpayers in the 10% and 12% brackets generally pay no tax on their capital gains.  Capital losses can offset capital gains and up to $3,000 of other income, with carryover to later years.  It’s also possible to avoid capital gains entirely by giving stocks, bonds or mutual fund shares owned more than one year to charity.  In addition, a deduction for the full fair market value is available for those who itemize.

Estimate itemized deductions — It’s estimated that only about 12% of taxpayers will itemize for 2018, thanks to boosts in the standard deductions and cutbacks in many itemized expenses.  The charitable deduction is still available, however.  There are several charitable options that may help taxpayers get over the standard deduction threshold, including some that allow donors to receive payments for life from their gifts.

Take required minimum distributions — IRA owners are required to take distributions from the accounts after age 70½.  These withdrawals are subject to tax at ordinary income rates.  A 50% penalty applies to amounts that should have been taken but weren’t.  A far more satisfying option might be to direct that some or all of the required distribution be sent to charity.  Although there is no income tax deduction, donors avoid the tax they otherwise would have paid on amounts sent to the charity.  Up to $100,000 may be given annually.

Revocable Charitable Gifts an Option to Consider

People who give to charity during their lifetimes enjoy tremendous personal satisfaction.  Tax savings can add an important fringe benefit.  There are several gift arrangements that can be adapted to a donor’s changing circumstances.  Here are some possibilities:

Bequests — Gifts by will are a traditional, flexible way to provide support to charity, and they can be amended at any time through a codicil.

Revocable living trusts — A trust is simply an alternative way of owning assets.   Trusts are often used to reduce or avoid probate costs, assure privacy and protect in the event of disability.  Charity can be added as a beneficiary of a living trust.  Anything received from the trust during your lifetime entitles you to a charitable deduction if you itemize.  Charity also can be named to receive assets from a trust, similar to a will.

Life insurance — You can name charity the revocable beneficiary of a life insurance policy and maintain lifetime financial security (the right to borrow against the cash value, for example).  You can also name charity as a contingent beneficiary, in the event the primary beneficiary dies first.

Financial accounts — IRAs, 401(k) plans, bank deposits, brokerage accounts and other financial arrangements can be made payable at death to particular individuals or charities.  You maintain complete control over the funds.  Anything remaining at death passes to the named beneficiary (who can be changed or deleted at any time).  Check with the financial institution for the proper forms.

Provide Family Support During Estate Administration

During the administration of an estate, many assets could effectively be tied up — outside the reach of family members.  It is important in planning your estate to keep some assets out of the probate process to meet the short-term cash needs of surviving spouse and family.  Although states generally provide allowances for the relief of the spouse and family, such amounts can be woefully inadequate.

There are several ways to provide a source of funds for family outside the probate estate.  These include:

  • Transfer of assets to the spouse before death; for example, to his or her bank account.

  • Purchase of life insurance.

  • Titling of assets jointly between spouses.

  • Beneficiary designations on IRA.

Alternative Route to IRA Funds

Even some seemingly ironclad rules have exceptions.  A case in point: the penalty on early withdrawals from IRAs.  Generally, taxpayers who withdraw funds from an IRA before reaching age 59½ are subject not only to income tax on the distribution, but also to a 10% penalty.

An exception allows early distributions if made as part of a series of substantially equal periodic payments for the life expectancy of the IRA owner.  Income tax is still owed on the distributions, but the 10% penalty is avoided.  Once started, payments must continue for the longer of five years or until reaching age 59½.  For example, Melody, age 49, wants to tap into her IRA.  She has a life expectancy of 47.5 years, according to IRS tables, so she would divide the balance in her IRA by 47.5 and take out that amount each year until she reaches age 59½.  Curt, age 57, has a life expectancy of 39.7 years.  He must continue taking the distributions for five years, even though he will have reached age 59½.  If withdrawals stop or if the amount is varied, the penalty is owed on all prior distributions.  There are variations to this general rule that permit increases or decreases, based on the balance in the IRA.

If taking distributions based on life expectancy would result in higher withdrawals than desired, the IRA can be split into two or more accounts, with distributions coming only from one.  For example, if Curt’s IRA were $2 million and he took distributions on the entire amount over his life expectancy, his annual distributions would be more than $50,000 ($2,000,000÷39.7 years = $50,378).  If he didn’t need that much extra income each year, he could transfer $500,000 to a separate IRA and take early distributions only from that account, giving him roughly $12,600 extra annually.  The remaining $1.5 million IRA would be left to grow tax-deferred.

Distributions taken prior to age 59½ result in a depleted retirement fund.  This technique is not appropriate for all taxpayers and should only be used after consultation with a tax advisor.


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