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.

Why Delaware Statutory Trusts (DSTs) Make Popular Real Estate Tax Deferral Solutions

Real estate can be a powerful asset to build your wealth and provide financial independence.  However, there may come a time when the “Three T’s” of real estate investing – Tenants, Trash, and Toilets – becomes old. While selling and sailing off into the sunset can appear alluring, the thought of settling up with the taxman can throw cold water onto the face of that dream. Fortunately, the tax code provides savvy real estate investors several options to sell, defer or eliminate capital gain taxes and maintain an income stream.  A few possibilities include Delaware Statutory Trusts, Qualified Opportunity Funds, and Charitable Remainder Trusts.

In this article, we will explore Delaware Statutory Trusts (DSTs). DSTs can allow an accredited investor to say adios to the Three T’s while also putting off, and potentially eliminating, the unpleasant notion of settling with Uncle Sam.

WHAT IS A DELAWARE STATUTORY TRUST?

A Delaware Statutory Trust is an investment trust that you can use for real estate ownership of high-quality, professionally managed commercial properties that provide a passive, turn-key solution for completing a 1031 Exchange.

Investors in a DST are not direct owners of real estate.  Instead, they own an undivided interest in the assets held by the trust.

The Delaware Statutory Trust holds title to the property for the benefit of the investors.  Each DST is established and managed by a “sponsor.” 

DSTs QUALIFY AS A 1031 LIKE-KIND EXCHANGE

The 1031 “like-kind” Exchange allows a real estate owner to defer capital gains (and depreciation recapture) taxes on a property sale when they use the proceeds to reinvest in qualifying properties.  If exchanging into direct ownership of another property, you defer the taxes, but the Three T’s remain the investor’s responsibility.  

The IRS recognizes Delaware Statutory Trusts as qualified replacement property for a 1031 Exchange.  By owning an undivided interest in the trust assets, the investor can enjoy the benefits of real estate ownership without the hassles of being a landlord.

OTHER ADVANTAGES OF DELAWARE STATUTORY TRUSTS OVER DIRECT PROPERTY OWNERSHIP

Institutional Quality Real Estate. DST’s allow real estate investors access to large, high-quality commercial properties that may otherwise be out of their reach. Partnering with a respected sponsor with better access to institutional quality properties and expertise in property management can help you expand your options when looking for replacement property.   

Diversification. Diversification helps to minimize risk in your investment portfolio. Many real estate investors tend to focus on one asset class, such as multi-family properties.  Delaware Statutory Trusts provide you the opportunity to own a diversified real estate portfolio (e.g., warehouses, storage, essential retail, etc.).   Additionally, DSTs can help you diversify your real estate portfolio geographically through ownership of quality properties in several areas of the country.  For example, you can sell one property in Chicago, IL, and exchange the proceeds into multiple Delaware Statutory Trusts that own warehouses in Austin, TX, multi-family properties in Denver, CO, essential retail in Nashville, TN, self-storage in Tampa, FL, etc.

Passive Income. Many real estate investors want or need to replace the income stream from their investment property. A DST portfolio can provide you an income from multiple properties that can potentially meet or exceed the net income from the sold property.  Most Delaware Statutory Trusts distribute income monthly.  Passive income without the hassles of direct property ownership can be an attractive exit strategy for property owners. 

Estate Planning Flexibility. You may prefer to manage your real estate property actively. Your spouse or heirs may not know how to take over that responsibility if something happens to you. DSTs can be a powerful estate planning tool because you can divide your interests amongst beneficiaries leaving each to decide what to do with their portion. Furthermore, the cost basis on the properties steps up to fair market value upon your death.

Closing with Confidence. Investors trying to complete a 1031 exchange can face uncertainty when identifying properties for an exchange and closing on the purchase within the required timeframe. Investing in Delaware Statutory Trusts may remove the uncertainty and hassle from the process. The Delaware Statutory Trust sponsor is responsible for doing the heavy lifting involved in setting up and managing the trust. You can close on the purchase of DSTs in short order compared to the time it often takes to close on a direct property purchase.  This allows you to seamlessly transition from selling your property into owning a diversified Delaware Statutory Trust portfolio.

Possible Disadvantages. DSTs are illiquid investments and therefore are only appropriate for long term investment horizons.  A typical DST may be liquidated by a sponsor after 5 to 10 years, and the investor will then have the option to exchange into another qualifying replacement property or to receive cash and pay any taxes due at that time.  Also, Delaware Stutory Trusts are only available for accredited investors.  Please read the disclosure at the end of this article.

Click here to read about other potential benefits of owning DSTs

DSTs can offer accredited investors some unique opportunities.  Under the right circumstances, they can be an effective solution for real estate investors looking to eliminate the dreaded Three T’s of being a landlord while deferring or eliminating taxes, maintaining a rental income stream, and continuing to enjoy the benefits of property ownership.   Consulting with an elite wealth manager who understands the unique needs of real estate investors can help you determine if owning Delaware Statutory Trusts is appropriate for your objectives.

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.

Little Known Ways for Business Owners to Reduce Taxes

Business owners have numerous ways to reduce their tax bills for both themselves and their companies.  Some of the methods are more commonly understood; however, many tax strategies are relatively unknown to even the brightest of entrepreneurs. 

Little-known tax strategies are not a secret because they are written in the tax code and approved by the IRS.  Wealth managers, accountants, and tax attorneys should all know about these and other ways for you to avoid paying more than your share of taxes.

BUSINESS OWNERS TAX STRATEGIES: QUALIFIED RETIREMENT PLANS

A qualified retirement plan meets the definition laid out in Section 401(a) of the tax code, allowing both business owners and employees to make pre-tax contributions, which then grow tax-deferred.  There are two basic types of qualified retirement plans: defined contribution and defined benefit plans.

Defined contribution plans, such as 401(k) plans, are more common.  Business owners benefit from tax strategies in two ways from such programs.  First, they can reduce taxable business income through employer contributions.  Second, they can reduce their personal taxable income by deferring part of their salary.

If you are over 50 years old, looking for ways to reduce taxable income and sock away a larger retirement nest egg, then a defined benefit plan may be your answer and can be an ideal solution for many business owners. 

Selling or transferring ownership of your business to new owners or family members can trigger a significant tax event.  One strategy that you can use to reduce a hefty capital gain tax on the sale is to freeze the value of your business. 

After you “lock-in” the business value, you will avoid capital gain taxes on any further increase in value.  Additionally, freezing the value can reduce or eliminate estate, gift, and generation-skipping taxes on any further value increase.  Freezing your business value can be a particularly effective tax mitigation strategy if you plan to transfer business ownership to children and grandchildren.

BUSINESS OWNERS TAX STRATEGIES: HIRE FAMILY MEMBERS

Hiring family members can yield significant tax benefits, particularly for small business owners under a sole proprietorship or single-member LLC.  For example, you can hire your spouse and provide all or most of their compensation in the form of a medical expense reimbursement plan.  This benefit is allowed in section 105 of the IRS tax code.

A section 105 plan allows for the tax-free reimbursement of healthcare and dental insurance premiums, along with out-of-pocket medical, dental, eye care, and other eligible medical expenses. Medical expense reimbursement plans can be significant tax savings for small business owners.

You can also hire your children to assist you in any number of ways. While they are minors, the salary you pay them is free from payroll taxes.  The salary is taxed at their minimal tax rate, and you can help them save the income for college.  

If your children attend college when they are 18 or older, they can claim themselves as dependents and receive tax credits up to $2500 annually.  Since this is a credit instead of a deduction, they can earn close to $40,000 annually free from federal taxes.  Compare that to the amount of taxes you would pay on the same $40,000, and you see how the tax savings of hiring your college-age children can add up.

CAPTIVE INSURANCE COMPANIES

Section 831(b) of the Internal Revenue Code allows business owners to set up their company as an insurance company as a wholly-owned subsidiary.  This captive insurance company ensures the risks of the parent company. 

The parent company funds the insurance operation tax-free.  The parent company also controls the premiums and claims, taking the commercial insurance company’s profit and the claims hassle out of the equation.  The investment income from the captive insurance operation is tax-exempt (not merely tax-deferred).

As a business owner, there are various types of captives for varying business needs. Still, most generally allow for tax-free funding of the insurance operation and tax-exempt income from the insurance operating profit. 

CHARITABLE TRUSTS

You can avoid capital gain taxes on the appreciated value of your business by first gifting the shares to a charitable trust before the sale.  Charitable trusts are powerful for business owners because it avoids capital gain taxes on the sale. 

It is best to use charitable trusts in combination with objectives other than tax reduction.  One example of this type of tax strategy is if you or a beneficiary you name can receive income distributions for life from the trust.  When you gift appreciated assets to a charitable trust, you also receive charitable tax deductions to help offset taxes on other income sources.

The Internal Revenue Code has hundreds of sections, many of which establish legitimate ways for business owners to avoid taxes and reduce the amount you pay to Uncle Sam over a lifetime.  Working with a tax-smart professional who understands your values, goals, and objectives can help guide you to the proper tax reduction strategies for you.

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.

Retirement Planning: Qualified Retirement Plans for Business Owners

qualified retirement plans, defined contribution plans, defined benefit plans, retirement planning, business owners

It’s no secret that business owners constantly search for different ways to reduce their tax obligations legally, especially when it comes to retirement planning. So why is it that so many successful business owners fail to take advantage of the government-sanctioned methods embedded in the tax code? Qualified Retirement Plans provide business owners with a legal way to reduce their annual tax obligations while also saving money to ensure they can fund the lifestyle they desire in retirement.

Although it sounds surprising, the government supports tax avoidance by intentionally creating ways to reduce your tax obligations legally. The government has social goals and offers incentives, written into the tax code, to those who participate in helping to achieve those goals. 

As the population continues to grow and the average lifespan continues to increase, the social goal of people having enough money saved to fund the rest of their lives once they are no longer working is becoming even more critical. Thus, the government uses Qualified Retirement Plans to motivate and incentivize people to save for retirement long before it becomes a concern.

WHAT IS A QUALIFIED RETIREMENT PLAN?

If you are a business owner, you have probably spent most of your adult life dedicated to your business. In some cases, that means saving for retirement took a back seat to the priority of building a successful business. Qualified Retirement Plans provide business owners with a legal way to reduce their annual tax obligations while also saving money to ensure they can fund the lifestyle they desire in retirement.

Qualified Retirement Plans typically allow you to contribute pre-tax dollars to an account intended to fund your retirement, helping you reduce your current taxable income by the contribution amount. The account grows tax-deferred and isn’t taxed until you withdraw funds from it when you more than likely move into a lower tax bracket during retirement years. For your retirement planning needs, reducing your current taxable income by the contribution amount while you are in a higher tax bracket and transferring it to a time later in your life when you may be in a lower tax bracket can be an attractive strategy for successful business owners.

When it comes to retirement planning for business owners, there are two different types of Qualified Retirement Plans: Defined Contribution Plans and Defined Benefit Plans.

DEFINED CONTRIBUTION PLANS

Most business owners preparing for retirement planning are familiar with Defined Contribution Plans—retirement saving vehicles that allow you to contribute a specified percentage or fixed amount of every paycheck to the plan. With this type of retirement plan, there are limits on how much the participant can contribute each year. Though there are limits, a Defined Contribution is more flexible of the Qualified Retirement Plan because you are not required to contribute every year.

For that reason, Defined Contribution Plans are generally more favorable to younger business owners who have a longer time horizon until retirement or for business owners with unpredictable cash flows. The retirement benefit is determined by the contributions made to the account and its investment performance over time; therefore, the expected benefit at retirement is uncertain.

Types of Defined Contribution Plans include 401(k) Plans, Profit Sharing Plans, and SEP-IRA Plans.

DEFINED BENEFIT PLANS

A Defined Benefit Plan can add significant value in maximizing personal wealth for the right business owner’s retirement planning. Defined Benefit Plans are retirement-saving vehicles that allow you to target a specified benefit amount to receive at retirement. The contribution amount is calculated and adjusted annually to ensure you reach the specified benefit amount upon retirement. There are no set maximum annual contribution limits. Therefore, a Defined Benefit Plan allows for significantly higher annual contributions—making the potential tax benefits for business owners considerably more significant than those of a Defined Contribution Plan. With that said, contributions to a Defined Benefit Plan are not discretionary.  You are required to make the calculated annual contributions to fund the plan adequately.

For those reasons, Defined Benefit Plans could be most beneficial to successful business owners nearing retirement and generating substantial cash flow consistently —making it an excellent option if you want or need to build up sufficient retirement assets quickly. Additionally, the contributions are tax-deductible, making Defined Contribution Plans an excellent tax reduction strategy during the contribution years.

Qualified Retirement Plans are written into the tax code, by the government, as a legal way to reduce your tax obligations to incentivize people to save for retirement.

Have you started saving for retirement?

If you’re a business owner and answered no, the benefits of setting up a Qualified Retirement Plan alone give you a great reason to start.

If you’re a business owner and answered yes, are you sure the type of retirement plan you have in place is the most effective solution for maximizing your wealth?

Whether you’re just starting or revising a Qualified Retirement Plan, many factors come into play when vetting out which type could be most effective for you and your business. Factors include your age, business cash flow, number of employees, entity structure, compensation, and retirement expectations. While most business owners could benefit from having a Qualified Retirement Plan in place, an ideal plan will help you more than others. Elite wealth managers that specialize in understanding the needs of business owners can help you navigate the complex landscape of Qualified Retirement Plans.

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.