Taxes and Your Social Security

Your benefits may be taxed. But a little up-front planning today can minimize the hit tomorrow.

After years of planning for that perfect retirement — diligently investing your money, drawing up detailed budgets and investing assets wisely — many investors continue to miss one important detail. As much as 85% of your Social Security income could be subject to federal (and possibly state) income taxes. That can be a real shock when you collect your first check.

How much of your Social Security income is subject to tax depends on a variety of factors, including your marital status and any additional income you earn. But with a little up-front planning, which can include everything from rebalancing your portfolio to structuring certain transactions (like the sale of a home or a business), you don’t have to let taxes derail your plans.

How Taxes Are Calculated

Social Security benefit taxes are based on what is commonly referred to as your “provisional income.” That includes half your Social Security income for the year, plus your modified adjusted gross income, which includes (among other items) any tax-exempt income. (Tax-exempt income includes interest from municipal bonds — often a core component of retirement portfolios.) After you cross these income thresholds, a portion of your Social Security benefits will be considered taxable income. (See the chart below for specifics.) For example, married couples who file their tax returns jointly and have provisional income of at least $44,000 could see up to 85% of their benefits get a haircut from the tax man.

How Provisional Income Is Taxed In 2011

A Longer-Term Strategy

Because of these income thresholds, tax planning experts often advise looking for ways to lower your provisional income. “When you plan for retirement,” says Vinay Navani, a shareholder with Wilkin & Guttenplan, an accounting and consulting firm in East Brunswick, New Jersey, “you need to think in terms of multiyear projections.” For example, if you anticipate a big one-time event such as the sale of a business, you may be better off structuring the sale as an installment sale to be paid off over several years instead of an all-cash transaction This can help lower your overall income and possibly keep you in a lower tax bracket, which would help minimize that tax hit on your SSI benefits.

You may also want to consider a longer-term strategy for drawing out of your qualified retirement accounts. That’s because all withdrawals from a traditional IRA typically will be included in your provisional income calculations. Income drawn out of a Roth IRA, however, is not. So you may want to consider withdrawing from the Roth first.

On the other hand, if you’re earning income in retirement, you can still contribute to an IRA, and contributions into a traditional IRA may be tax tax-deductible, lowering your provisional income. A word of caution, though, if you are considering converting a traditional IRA to a Roth: Any amount you move will also be counted as income. That may be worth it, though, because of the Roth’s other tax advantages.

Another option is to convert an investment that earns taxable income, such as a taxable bond portfolio, into a tax-deferred account, such as a deferred annuity. You could structure the annuity to begin paying income in a few years, when you expect your provisional income, as well as your overall tax rate, to decline.

Know the Penalties

Those hoping to work in retirement need to be especially careful if they’re planning to claim Social Security benefits early. According to a 2010 study by the Families and Work Institute and the Sloan Center on Aging & Work at Boston College, three-quarters of workers age 50 and older say they expect to hold some kind of income-generating job after retiring. It’s important to consider how that income will affect your benefits.

The Social Security Administration caps how much you are allowed to earn if you start taking your benefits before “full retirement age,” which the SSA considers 66 for most baby boomers. In 2011, the annual earned income cap is $14,160, and for every $2 you earn over that limit, the SSA trims $1 off the top of your benefits. So if you earn $20,000 this year, and you haven’t yet reached full retirement age, your benefits will be reduced by $2,920 — on top of any income taxes you may have to pay on the remaining benefits.

There is some good news, however: Because the penalty is determined by your individual earned income, if you retire early and your spouse doesn’t, and if you file separately, your spouse’s earned income will not be factored into any benefit cuts that could apply. However, if you file jointly, your spouse’s earnings will be included when calculating your provisional income. Additionally, when you reach your full retirement age, the earned income penalty disappears.

Forewarned Is Forearmed

Lastly, do a bit of homework. Worksheets in IRS Publication 915, Social Security and Equivalent Railroad Retirement Benefits, available at, can help you compute your tax liability. Then check with your state to see whether it taxes benefits. You might not be able to avoid taxes, but at least you’ll know what to expect and will be able to plan accordingly. As always, your Financial Advisor can work with your tax professional to find the best solutions.

Source: Forbes

Undoing a Roth IRA conversion

If you converted a traditional individual retirement account into a Roth IRA last year only to watch the value of the account fall, you could save taxes by undoing the conversion by Oct. 17.Undoing a Roth IRA conversion

But there is a risk: When you undo the conversion, the money goes back into a regular IRA and you must wait at least 30 days before you can convert back into a Roth again. If the value of your account soars during those 30 days and you want to convert again, you could owe more tax than if you had left well enough alone.

“It’s a gamble,” says Mike Gray, a San Jose certified public accountant.

Roth conversions skyrocketed in 2010 because it was the first year people with more than $100,000 in income could do it.

At Fidelity Investments, customers converted about 220,000 regular IRAs into Roths last year, more than quadruple the previous year’s total. About one-third of last year’s conversions were done in December, when most stock markets worldwide were higher than they are today.

That means more people than usual will at least consider undoing Roth conversions this year.

Money in a regular IRA has never been taxed, so when you convert it into a Roth IRA, you must add the entire amount converted into your ordinary income and pay tax on it.

Normally you must report the income in the year of the conversion. But for 2010 conversions only, investors had the choice of putting all the income on their 2010 tax return or splitting it 50-50 between 2011 and 2012.

The benefit of a conversion is that once the money is in a Roth IRA, it is never taxed. Investors can take it out tax-free (assuming they meet certain holding requirements) or let it continue to grow. Unlike regular IRAs, they do not have to take mandatory withdrawals starting at age 70 1/2.

Like it never happened

Another perk is that you can reverse – or in tax lingo recharacterize – the conversion if the market turns against you. You simply put the money back into a regular IRA and pretend the conversion never happened.

Suppose you converted $100,000 into a Roth IRA in December 2010 and added the $100,000 to last year’s income.

Now suppose the value of your Roth IRA has dropped to $80,000. If you do nothing, you owed tax on $20,000 that has evaporated.

No problem: You undo the 2010 conversion by putting the money back into your regular IRA by Oct. 17 of this year. This involves contacting your bank or broker and filling out some paperwork.

This move takes the $100,000 out of your 2010 income.

If you haven’t yet filed your 2010 tax return, just leave out the $100,000 when you file it. (The extended tax-filing deadline for 2010 is also Oct. 17.)

If you have already filed your 2010 tax return, you would amend your federal and state returns and remove the $100,000 in conversion income. You can file an amended return after Oct. 17.

What if you were planning to split the $100,000 between 2011 and 2012 income?

If you already filed your 2010 return, you should have stated your intention on Form 8606 and filed it with your 1040. You will need to amend your federal and state tax returns including Form 8606.

If you haven’t filed your 2010 return, you would not have to do anything.

Waiting period

If you undo your conversion, you must wait at least 30 days before you can convert your regular IRA back into a Roth. As long as the value of your regular IRA stays below $100,000 before you convert again, all this maneuvering will pay off, assuming your other income and deductions haven’t changed drastically and your tax rate remains the same.

But what if the value soars above $100,000 – say to $110,000? When you convert back into a Roth, you will owe tax on $110,000 in income instead of $100,000. If your tax rate has not changed, you will owe more tax.

Deciding whether to undo a Roth conversion depends on where you think the market, your income and tax rates are headed.

If the value of the Roth IRA “went down by a small amount, I wouldn’t fuss with it. It’s going to be a pain,” Gray says. For a $100,000 account, he says, “it would have to be down 15 to 20 percent before I would do anything.”

For a $1 million account, the threshold might be lower because the potential tax savings would be bigger. But even on a large account, the smaller the percentage loss in value, the bigger the risk it could bounce above its original conversion value and come back to haunt you.

10 percent loss

Sandi Bragar, a wealth manager with Aspiriant, says her firm is considering it for accounts that are down 10 percent or more.

The Standard & Poor’s 500 index is down 8.5 percent so far this year, so if your Roth IRA is invested mainly in large-cap U.S. stocks, it probably won’t pay to undo it.

Where it usually makes sense is if the Roth IRA was invested heavily in emerging markets or overseas stocks – which are down 15 to 20 percent or more – or in U.S. sectors that have been especially hard hit, such as small-cap stocks or real estate investment trusts, Bragar says.

If you converted into several separate Roth IRA accounts last year, you can undo some and not the others.

If you converted into a single Roth IRA, you can undo a percentage of it. If you want to recharacterize 20 percent, for example, you would move 20 percent of each individual holding back into a regular IRA.

Another trick: Suppose you converted only some of your regular IRA into a Roth last year and now want to undo the conversion but are afraid the market will rebound. To get around the 30-day waiting period, you can convert all or some of your regular IRA into a Roth IRA and the next day, undo your 2010 Roth conversion and put that money back into your regular IRA, Bragar says.

Source: SFGate

Self-Direct Your Retirement

If you didn’t know anything about the stock market before October 4, you’d think the US had the strongest economy ever. The Dow rallied more than 1,220 points since then – a gain of 12%! Naturally, the uninformed investor may think it’s time to jump into this bull market.

However, thousands of investors are waking up to the reality of Wall Street – that it’s become more of a Vegas gamble than an investment based on fundamentals. Nothing is backing this latest rally, except for a few headlines swaying public sentiment.

When the media announces that Europe has found a temporary solution, stocks rise. Then when the uncontrollable debt inevitably rears its ugly head again, stocks plunge. Is this where you want your precious life savings?

Americans have lost over $6.6 trillion of their retirement savings due to the volatile stock market, according to a study commissioned by Retirement USA. Thousands of investors have had enough and are looking into alternatives to traditional tax-deferred retirement plans.

The dream of letting someone else manage their money and expecting it to be ready and waiting for them after 30 years is dead. One of the savvier investor’s best kept secrets is one you probably haven’t heard about from your traditional financial planner: the self- directed IRA.

With a self-directed IRA, you can take control of your retirement by choosing over 45 different types of investments outside of Wall Street – without penalties. Here’s a partial list of what you can do with your self directed IRA:

  • Residential real estate, including: apartments, single family homes, and duplexes
  • Commercial real estate
  • Undeveloped or raw land
  • REITs (Real Estate Investment Trusts)
  • Real estate notes (mortgages and deeds of trust)
  • Private limited partnerships, limited liability companies, and C corporations
  • Tax lien certificates
  • Foreign currencies
  • Oil and gas investments
  • Private stock offerings, private placements
  • Gold bullion

The IRS actually only disallows two investments within the IRA: Life Insurance Contracts and Collectibles ( Pub 590). Everything else is fair game so long as it’s for “investment purposes only.”

If you wanted to self-direct your IRA to buy real estate and take advantage of today’s bargains, you could not invest in a home for you to live in or a second home to use for vacations. However, you could buy a rental property, and all the rental income would flow back into the IRA tax-free or tax-deferred.

A great benefit of investing with money from your IRA is your ability to let money grow year after year, compounding faster without the loss of tax payments. Real estate values have overcorrected in many parts of the US. If your IRA bought a discounted property that increased in value over time, all the profit upon sale would go back into the IRA – tax-deferred.

Some banks even offer financing for your self-directed IRA. However, to avoid paying UDFI taxes, use a self-directed 401K instead if you plan to leverage your real estate purchase.

A great benefit of a self-directed 401(K) plan is the large annual contribution limits allowed. Businesses with a spouse on the payroll can also contribute to the Solo 401k. Provided the business owner and spouse have sufficient income from the business, taxpayers may be able to contribute up to $49,000 each ($54,500 each if both are age 50+) in 2011.

That Solo K Plan would allow the taxpayer to contribute a total of $109,000 during the year, and save close to $50,000 in taxes. This is significantly higher than the IRA contribution limit of $6,000. You get a huge tax write off in the years of contribution, and the funds can be immediately utilized to invest into real estate and receive tax deferred treatment. (Verify with your tax professional.)

Most types of retirement accounts can be converted into a self-directed 401(k) plan. However, if you discuss this option with your traditional financial planner, you may be highly discouraged to proceed.

Remember, most traditional financial planners only get paid when your assets are under their management. Why wuld they encourage you to leave them, even if it’s a better deal for you?

Source: Townhall Finance