Roth IRA Conversions At A Discount

Roth IRA Conversions At A Discount

The stock and bond markets are off to a rough start in 2022. The odds are that your portfolio has taken a haircut since the beginning of the year, particularly for investors with a passive buy-and-hold strategy. While watching your portfolio drop in value may be painful, the recent pullback may have a silver lining. A Roth IRA conversion strategy can be an effective lifetime tax minimization plan. 

When your IRA account declines, it can be your opportunity to implement a Roth conversion strategy and incur fewer taxes than you would have before the market correction. If you have already started a Roth conversion strategy, lower account values can be an opportunity to accelerate phases of your plan.

START WITH THE BASICS

When you contributed to your traditional IRA or 401(k), you likely did so with pre-tax dollars, which reduced your taxable income in the years you made the contributions. Contributing to your Retirement plan with pre-tax dollars is a powerful incentive for you to save a portion of your income for your retirement years.  

Additionally, your IRA account grows tax-deferred, meaning you won’t pay taxes on the growth until you withdraw funds from your account, typically in your retirement years.

BENEFITS OF ROTH IRA ACCOUNTS

While reducing taxes in the years you make the contributions, traditional IRA’s and 401(k)’s can increase your tax bill later in life when you withdraw funds from your account. Not only are your initial contributions taxed, but so is all the growth accumulated over the years.  

Even if you don’t need to withdraw funds from your traditional IRA for living needs, tax laws require you to start. Required Minimum Distributions at age 72. Afterward, you will pay taxes on the required distributions every year for the rest of your life. 

On the other hand, you fund Roth IRA and 401(k) accounts with after-tax dollars, meaning that you pay taxes in the year that you make your contribution or convert from a traditional to a Roth account. However, Roth accounts provide potentially significant benefits later in life.

For one, when you withdraw funds from Roth accounts in retirement, the withdrawals are tax-free. Not only can you withdraw your initial contributions or conversion dollars tax-free, but also years of potential investment gains.   

Another benefit of Roth accounts is that tax laws do not require you to withdraw funds at age 72. You can continue to invest the funds for many more years, continuing the tax-free benefits for your and your spouse’s needs later in life.

Finally, if your heirs inherit Roth accounts, they can withdraw funds tax-free. Meanwhile, if they inherit traditional IRAs, they will have to pay taxes at ordinary income rates on withdrawn funds. Even if leaving a legacy is not your highest priority, a portion of your IRA is likely to pass to the next generation, making Roth accounts a highly tax-efficient way to transfer your wealth.

SO WHY DOES THE DECLINING MARKET HAVE A SILVER LINING?

When your IRA account declines with the market, it can be your opportunity to implement a Roth conversion strategy and incur fewer taxes than you would have before the market correction. 

HOW DOES IT WORK?

At the beginning of the year, let’s assume your traditional IRA account was valued at $1 million. Further, suppose that you plan to convert $200,000 each year to a Roth account, so all of your traditional IRA is converted in the next five years. 

If your lifetime tax plan includes a Roth conversion component, you may want to consider implementing a portion when stocks and bonds are at depressed levels. If, for example, your IRA account dropped to $800,000, you can accomplish the same goal in the next four years by converting the same $200,000 annually.

Another reason many are considering Roth conversions today is the tax environment. While no one can know what will happen to tax rates, the current tax law, the Tax Cuts and Jobs Act of 2017 (TCJA), lowered rates for most families.

Unfortunately, TCJA is only temporary. Tax rates are scheduled to revert to 2017 levels beginning in 2026. Performing Roth conversions today at lower tax rates can significantly reduce your taxable income later in life when rates are designed to increase.

BEFORE JUMPING INTO A ROTH CONVERSION STRATEGY

You should have a well-thought-out lifetime tax minimization plan. It is difficult to determine if Roth conversions make sense for your situation unless you do some reasonably sophisticated analysis, typically using specialized software. 

Roth conversion strategies can significantly affect your lifetime tax minimisation plan. Executing conversions when portfolio values are depressed can mean significant tax savings. 

Are your plans appropriate in the current market, economic, and tax environment? Consider seeking a second opinion from a wealth manager with tax planning expertise to refine your Roth conversion or lifetime tax minimization plan. 

By: John Hollahan

DISCLOSURE & ACKNOWLEDGEMENT

To be an “accredited investor,” an individual must have had earned income that exceeded $200,000 (or $300,000 together with a spouse) in each of the prior two years and “reasonably expects the same for the current year.” Or, the individual must have a net worth of more than $1 million, either alone or together with a spouse, excluding one’s primary residence

The information included in this material is for informational purposes only and should not be relied upon for any financial or legal purposes. Arlington Capital Management Inc, dba Arlington Wealth Management (AWM) is an investment adviser registered with the U.S. Securities and Exchange Commission.  Our registration with the SEC or with any state securities authority does not imply a certain level of skill or training, nor are we selling you any product.  Rather, we are seeking to provide you with advisory services.   Please consult with your own tax and legal advisers before investing. AWM cannot and does not guarantee the performance of any investment.  Past performance is no guarantee of future results.

Family LLC or Family Foundation: How Can My Family Benefit?

Families can use several advanced planning tools to achieve their values, goals, and objectives.  Along with preserving family wealth, many families are interested in reducing taxes, effectively transferring wealth across multiple generations, protecting assets from catastrophic loss, and making impactful charitable gifts.  A Family Limited Liability Corporation (LLC) or a Family Foundation are two worthy options for you to consider.

FAMILY LIMITED LIABILITY CORPORATIONS (FAMILY LLC)

A Family LLC is a legal entity that enjoys the limited liability of a corporation and the operational flexibility of a partnership. Most people who set up Family Limited Liability Corporations are typically larger estates, looking to minimize state and federal estate taxes and avoid paying gift taxes. A Family LLC can benefit from owning rental properties, brokerage accounts, or a family business. Having a Family Limited Liability Corporation can protect your family members from creditors, help with estate planning, and divide income among the members.

You will want to have an operating agreement that limits and defines ownership and transfer rights. Some Family LLC could provide significant discounts from estate and gift tax.

ADVANTAGES OF A FAMILY LLC

One of the main benefits of a Family LLC is that you can transfer a family business with ease to the next generation. A Family Limited Liability Corporation acts as a pass-through for income tax purposes, minimizing federal gift and estate taxes.  

For successful business owners, a Family LLC can reduce income taxes by spreading business income across multiple family members and generations that may be in lower income tax brackets.    

Owners retain control over the assets and can protect younger members from financial decisions.

A Family Limited Liability Corporation can be an excellent vehicle to protect the assets against claims by creditors, divide income among generations, and facilitate multi-generational wealth transfer and estate planning.

DISADVANTAGES OF A FAMILY LLC

You cannot blend personal and business assets in a Family Limited Liability Corporation.

A Family LLC must meet IRS requirements; there could be consequences if you form a Family Limited Liability Corporation only to avoid paying taxes.  Also, the general partners of a Family LLC can be vulnerable to some risk, so it is a good idea to work with an elite wealth manager and a team of experienced and knowledgeable professionals in this area.

The members of the Family LLC pay taxes on their share of the entity’s profits, and there will be initial and annual fees associated.

FAMILY FOUNDATIONS

A Family Foundation, also known as a private foundation, is a not-for-profit organization mainly funded by a person, corporation, or family. The assets within the private foundation will generate income, which is used to support the foundation’s operations and make charitable grants to other nonprofit organizations. In addition, a family foundation can help foster family connections and instill family values for the younger generations.

ADVANTAGES OF A PRIVATE FOUNDATION FOR YOUR FAMILY

A private foundation gives you control over the choice of charitable organizations to which you want to support. In addition, you and your wealth manager can choose how to invest the assets in the foundation.

With a private foundation, succession possibilities are endless. With your family involvement, you will create a legacy and bond as a family around something meaningful.  You can have a clear vision of how you want to make a difference in the world and which causes you to want to support.

Family Foundations provide significant tax benefits.  You can avoid paying capital gain taxes on appreciated assets, including private business shares, public stocks, real estate, etc., by donating the assets to your foundation and then selling.  Since the Private Foundation is a tax-exempt entity, the sale incurs no capital gain tax. 

Additionally, you can claim a significant charitable deduction for the total market value of the assets donated to the Family Foundation, which can help offset taxes on other income sources.  The tax deduction can be carried forward for several years to continue providing tax benefits years after the donation. 

When you transfer assets to a Family Foundation, they are usually not subject to estate taxes; this can provide three types of tax savings combined with the tax benefits described above.

DISADVANTAGES OF A PRIVATE FOUNDATION FOR YOUR FAMILY

Setting up a Family Foundation is time-consuming, and there will be legal, and accounting fees associated with the setup and ongoing maintenance of the foundation.  There are regulatory and other reporting requirements, usually completed by your accountant and attorneys each year.

Assets transferred into a Private Foundation from you are irrevocable. You can’t change your mind once the transfer is complete.

There are annual excise tax payments; most foundations pay a 1 to 2% annual excise tax on their net income. This percent depends on the foundation’s annual grantmaking.

Family Limited Liability Corporations and Family Foundations are two effective strategies to help achieve what’s important to you and your family.  They can help you live a life of significance, accomplish your aspirations, and leave a multi-generational legacy. 

Both of these tools have significant advantages for the right family.  However, both have their share of disadvantages too.  If a Family LLC or a Private Foundation is not a good fit for your situation, there are many other options to consider.  It would be best to consult with your wealth manager and other advisors to determine the best solutions for your circumstances.

DISCLOSURE & ACKNOWLEDGEMENT

The information included in this material is for informational purposes only and should not be relied upon for any financial or legal purposes. Arlington Capital Management Inc, dba Arlington Wealth Management (AWM) is an investment adviser registered with the U.S. Securities and Exchange Commission.  Our registration with the SEC or with any state securities authority does not imply a certain level of skill or training, nor are we selling you any product.  Rather, we are seeking to provide you with advisory services.   Please consult with your own tax and legal advisers before investing. AWM cannot and does not guarantee the performance of any investment.  Past performance is no guarantee of future results.

What Types of Charitable Giving Accounts Might Be Best for My Family?

The variety and complexity of charitable giving options can be overwhelming.  A wealth manager with expertise in charitable giving can help guide you to an intelligent philanthropic approach. So put away the checkbook, and let’s review two charitable giving options: Donor-Advised Funds and Charitable Remainder Trusts. 

An increasing number of families and business owners want to support the causes they care about, both while they are alive, and after they pass. For charitable-minded families, several gifting vehicles not only help you better meet your philanthropic goals but can also help you address other important issues –  reducing taxes, increasing cash flow, transferring wealth efficiently, and protecting your assets.  The optimal charitable strategy for you will depend on your values, goals, and objectives.

DONOR-ADVISED FUNDS

A Donor-Advised Fund is a 501c(3) charity organization that receives donations from you, allows you to invest those contributions, and specifies whom you want to grant your gifts. Donor-Advised Fund accounts are easy to use. Most large brokerage firms such as Charles Schwab, Fidelity, and Vanguard have user-friendly client portals, which can come in handy if you donate to several charities.

With a Donor Advised Fund, you receive an immediate tax deduction when you fund the account, and the account can grow tax-free based on the performance of the investments selected. It is typically best to fund the account with appreciated assets you would otherwise pay capital gain taxes on the sale because you eliminate capital gains tax. Tax mitigation is the main reason people chose donor-advised funds as a charitable gifting vehicle.

Some firms that offer donor-advised funds have account size and donation minimums, so you will want to find out what they are before opening your account. Once you fund the account, the invested money remains in the account until you decide which charities make gifts, which could be at any time, even years down the road.

CHARITABLE REMAINDER TRUSTS (CRT)

A Charitable Remainder Trust can generate an income stream for yourself or any person(s) you choose. You can design the income to be for a set period or your lifetime. Once the trust disperses the funds to the named beneficiaries, the trust gifts the remaining assets to charities that you choose. It also provides you an immediate charitable deduction in the year you fund the account.

A Charitable Remainder Trust has several potential benefits.  First, it helps fulfill your charitable gifting goals.  Second, it helps provide income for your living needs or any person(s) you choose.  Third, the trust assets grow tax-deferred.  Additionally, you are eligible for an immediate tax deduction to help offset other taxable income.  Finally, the assets are removed from your estate, potentially helping to reduce estate taxes.

There are two caveats in a Charitable Remainder Trust you should understand.  You have to select the charities when you establish the trust, years before the gift will occur. For this reason, some people will choose their donor-advised fund as the charitable beneficiary of the trust because they can have more control over naming and changing charities that receive the remaining funds.  Also, the trust is irrevocable, meaning that you cannot change your mind once the assets are transferred to the trust.  You give up ownership of the assets in return for the potential income stream.

THERE ARE TWO DIFFERENT KINDS OF CRTs:

Charitable Remainder Annuity Trust (CRAT) and a Charitable Remainder Unitrust (CRUT)

A CRAT will pay a fixed dollar amount to the person you designate for a set number of years, with a maximum of twenty years. For example, you can select the amount at $45,000 annually.  You cannot change the payout amount once set even if the trust assets grow more than the distribution.  You also cannot add future assets to a CRAT once it is established.

A CRUT pays a set percentage of the trust assets each year, instead of a fixed dollar amount in a CRAT. For example, you can choose to pay out 7% of the trust assets annually.  The income stream varies each year based on changes in the trust value as it increases or decreases. The annual payment increases or decreases with the value of the assets in the trust.

WHAT ARE THE BEST ASSETS TO GIFT?

Your best option is to gift appreciated assets (stocks, real estate, private business shares, etc.) that will otherwise incur a capital gain tax upon the sale.  Once you make the gift with the appreciated assets, you eliminate the capital gain tax liability.  The charitable giving vehicle – Donor-advised fund or Charitable Trust – sells the investment in a tax-exempt structure.  Compare this strategy to first selling the asset, paying the tax, and then gifting cash. Ideally, you will never make charitable gifts with cash. 

Affluent families practice intelligent philanthropy using IRS-approved tools to make more impactful charitable gifts while also improving their financial security.  You don’t have to be ultra-rich to benefit from the same strategies.  Make sure your advisor is knowledgeable with philanthropic planning or has access to experts in this field.  

Charitable Trusts and Donor-advised funds can be wise options to help you meet your philanthropic goals.  These charitable giving vehicles can also improve your personal finances significantly with the potential for increased income streams and reduced taxes. 

DISCLOSURE & ACKNOWLEDGEMENT:

The information included in this material is for informational purposes only and should not be relied upon for any financial or legal purposes. Arlington Capital Management Inc, dba Arlington Wealth Management (AWM) is an investment adviser registered with the U.S. Securities and Exchange Commission.  Our registration with the SEC or with any state securities authority does not imply a certain level of skill or training, nor are we selling you any product.  Rather, we are seeking to provide you with advisory services.   Please consult with your own tax and legal advisers before investing. AWM cannot and does not guarantee the performance of any investment.  Past performance is no guarantee of future results.

President Biden’s Tax Plan: How Will it Affect Family Wealth?

The tax increases proposed in President Biden’s tax plan are aimed squarely at business owners and family wealth.

The good news: You may still have time to prepare for any tax law changes that result from the proposal—still must wind its way through the legislative process and be signed into law by the President.  That means Congress can make any number of changes to the proposal.

While it is possible any new tax law would be retroactive to January 1, 2021, most experts feel that it is not likely.  That means that you may still be able to implement tax-smart strategies this year. 

BIDEN’S TAX PLAN IS COMING AFTER FAMILY WEALTH FROM MULTIPLE ANGLES

President Biden’s tax plan has made it clear that he wants to raise tax revenue; he also has made it clear that he wants the source of the additional taxes to come from businesses and the wealthy.

With Democrats holding a narrow majority in the U.S. House of Representatives and Senate, there is no way to predict how the proposed plan will compare with tax law changes that President Biden may eventually sign into law.  But, Biden’s tax plan, as currently proposed, seeks to increase taxes on family wealth from several sources:

  • Increased marginal income tax rates
  • Increased capital gains taxes
  • Increased estate taxes after death

If you are a business owner, you will want to explore proposed changes for businesses.  While no one has a crystal ball, the current administration will likely implement some tax law changes.  Total U.S. Public Debt soared over 19% in 2020 as the government responded to the economic crisis created by the COVID-19 lockdown.  At the end of 2020, federal debt totaled over $27 trillion.  There is mounting pressure to begin to deal with the increasing deficit somehow, and President Biden’s American Families Plan aims to do just that.

BAD NEWS FOR FAMILY WEALTH TAXES

Your family’s wealth could be affected by several critical provisions of Biden’s tax plan proposal.  Some of the most impacting issues include:

  • Increase to the top marginal income tax rate.  The proposal includes raising top rates from 37 percent to 39.6 percent.  That would apply to income over $452,700 for those filing as single and head of household and $509,300 for joint filers.
  • Increase to Capital Gains and Dividend tax rates.  The plan calls for increased capital gain and dividend taxes for families with a taxable income above $1 million per year.  Long-term capital gains and dividends would be taxed at the top ordinary income tax rate of 39.6%.  Adding in the 3.8% Net Interest Income Tax (NIIT), the effective tax rate would be 43.4%.  Currently, the maximum tax rate for long-term capital gains and dividends is just 20%, or 23.8%, when including NIIT.
  • Increased taxes after Taxpayer(s) death.  These proposed changes could carry significant tax implications for your heirs.  The plan would tax unrealized gains greater than $1 million upon your death, even if your heirs have not sold the asset.  The current tax code allows for a step-up in the cost basis of unrealized gains to the value on the date of death, effectively eliminating the capital gain tax liability for your heirs.  Additionally, an estate tax can be due on the same asset if your estate size exceeds specific levels.  According to the Tax Foundation, the combination of capital gain, NIIT and estate taxes can add up to a total tax rate of 61% on unrealized gains over $1 million.  There is likely to be additional state taxes depending on your state of residence.  All of these taxes add up to only a small percentage getting passed to your heirs.  Suppose you owned a private business or investment real estate that has appreciated over many years. Your lifelong asset accumulation would largely be swept up in taxes when you die.

Which provisions in President Biden’s tax plan may potentially affect your family? It all depends on your unique situation.  An experienced wealth manager knowledgeable in advanced tax planning for family wealth, business owners or real estate investors can help guide you in a proactive tax mitigation plan.

ANALYZE YOUR FAMILY’S TAX SITUATION

Each family could potentially be affected in different ways by any new tax law.  Here are some ways to think about the potential impact.  Of course, families may fit more than one of the categories below.

  1. High Earning Families. If you earn significantly more than $500,000, you will likely pay more in taxes under the proposed plan.  Your goal could be to seek out strategies that will lower your taxable income.  For example, you might investigate income deferral plans with your employer.
  2. Families with Large Unrealized Capital Gains.   Suppose you have taxable income greater than $1 million and are sitting on significant unrealized long-term capital gains in assets. In that case, you will likely pay a much higher rate when selling the asset.  For example, suppose you are a long-term employee that accumulated many shares of your employer at a low cost-basis. In that case, you will pay significantly more in capital gains taxes under the proposed plan.  Owners of private businesses and appreciated real estate fall into a similar predicament.  Your priority could be to look for strategies that would help reduce, defer or eliminate the capital gain tax liability.  For example, you might investigate tax-loss harvesting strategies to minimize total capital gains for the tax year.  You can also consider advanced charitable trust strategies that can eliminate the capital gain tax.
  3. Families Preparing for the Transfer of Assets.  Suppose you have family assets that have appreciated significantly over the years. In that case, you may be sitting on significant unrealized capital gains that upon your death would be treated differently under the proposed tax plan.  Under the proposed law, capital gains greater than $1 million would incur a tax rate as high as 43.8% in addition to potential estate and state taxes when you die.  In these situations, your goal would be to search for advanced tax planning strategies designed to mitigate the tax liability for your heirs and wealth transfer strategies designed to reduce or eliminate your wealth transfer tax burden. One positive note here – lawmakers intend to build in exclusions for family-owned businesses and farms if the heirs continue to run the business. 

GETTING PROFESSIONAL HELP

Proposals in President Biden’s tax plan are aimed squarely at increased taxes on family wealth, successful business owners and real estate investors.  Your family’s situation is unique. Any number of the proposed tax increases can affect your family’s wealth depending on your unique situation.  Contact your team of advisors to assess your position relative to the proposed changes, identify areas of concern, and develop a plan to address those concerns.  An elite wealth manager can help you create a custom advanced wealth plan to minimize your tax liability.  If you don’t take proactive action and plan for potential changes, you may be caught flat-footed and miss opportunities to minimize taxes.

DISCLOSURE & ACKNOWLEDGEMENT:

The information included in this material is for informational purposes only and should not be relied upon for any financial or legal purposes. Arlington Capital Management Inc, dba Arlington Wealth Management (AWM) is an investment adviser registered with the U.S. Securities and Exchange Commission.  Our registration with the SEC or with any state securities authority does not imply a certain level of skill or training, nor are we selling you any product.  Rather, we are seeking to provide you with advisory services.   Please consult with your own tax and legal advisers before investing. AWM cannot and does not guarantee the performance of any investment.  Past performance is no guarantee of future results.