Archive for March, 2012

Federal Tax Laws: More Change Coming

Monday, March 26th, 2012


There are many changes  in the Federal Income Tax Laws that have been implemented already or will be soon. Some expired last January others will expire by year end. Tax increases are also on the horizon.

 

Newly Expired Tax Laws

 

The first five were temporary tax relief items that expired January 1st of this year are:

 

1. The Alternative Minimum Tax (AMT) Patch – This expiration will subject many more taxpayers with tax preferential items such as, tax free income or substantial itemized deductions, to be subject to the Alternative Minimum Tax.

 

2. Charitable Contribution of IRA Assets – The exception allowed taxpayers to transfer assets directly from their qualified accounts to charity without paying income tax. With the expiration of this provision, taxpayers must now first pay Federal Income Tax on the withdrawal and then may transfer an amount to the charity.

 

3. State Sales Tax Deduction – The deduction was an alternative which allowed taxpayers to take the higher of their state sales taxes or income taxes paid as an itemized deduction. The change will mostly affect people living in states without state income taxes and seniors in states where retirement income is not subject to state income taxes and therefore not deducted.

 

4. Home Energy Tax Credit – This was a credit available for windows, doors, heating systems, cooling systems, etc. After January 1, 2012, these improvements no longer qualify for a tax credit.

 

5. School Teachers Expenses Deduction of $250 – School teachers who have been dipping into their own pockets for items used in their classrooms, used to be to take a $250 deduction to account for these expenses.

 

Year End Expiring Tax Laws

 

The next impending batch of tax laws which are scheduled to expire at the end of 2012, barring any intervening Congressional actions, are:

 

1. Payroll Tax Cut of Two Percentage Points – This is a reduction in the amount of social security taxes that has been withheld from employee paychecks. The expiration of this cut will result in the resumption of the scheduled 6.2% withholding for FICA taxes.

 

2. Top Income Tax Rate Cap – The rate will increase from 35% to 39.6%.

 

3. Capital Gains Tax – Both the 0% and 15% tax brackets will disappear. They will be replaced by a single 20% bracket.

 

4. Qualified Dividends Tax Rate – No longer will dividends that meet the qualifications of this category be taxed at 15%. These are scheduled to revert to ordinary income tax status.

 

5. American Opportunity Education Credit – This credit (up to $2500), was available to offset some of the costs of post secondary education, is also set to expire 12/31/2012 as well.

 

January 2013 Tax Increases

 

There is also several tax increases scheduled to become effective on January 1, 2013. Among the most noteworthy:

 

1. Net Investment Income Tax – There will be an additional tax of 3.8% for individuals with Adjusted Gross Incomes of $200,000 and couples with AGI’s greater than $250,000. The purpose of this additional tax will be for additional Medicare funding.

 

2. Phase-out of Personal Exemption – For higher income taxpayers, the amount of their personal exemptions will be phased out as income increases.

 

3. Itemized Deductions Limit – These deductions will be limited for taxpayers with incomes exceeding $150,000.

 

4. Flexible Spending Accounts – FSA funding is being cut from $5000 to $2500.

 

With this plethora of changes already in place or on the horizon, what is a taxpayer to do? The answer to that is as individual as the person reading the question.

 

If, you are in an effected tax bracket and are contemplating liquidating an equity position that you currently own, it may be in your best interest to consider this transaction in 2012 before the increased tax rates will diminish your after tax return. If there is a way to pay for itemized deductions this year, if you are possibly in jeopardy of getting them phased out next, that may be a good choice for you.

 

The bottom line is to keep these changes in mind when making financial decisions in the upcoming year.

 

Kurt Rusch CLU,ChFC

 

Why Most American Workers Do NOT Participate in 401(k) s

Saturday, March 10th, 2012


67 percent of Americans workers aged 21-64 with access to employer-sponsored 401(k)’s do not participate in the pre-tax retirement plan.

 

I was absolutely floored when I read this stat published by the Employee Benefit Research Institute. There had to be a typo in there somewhere. (I double checked; there wasn’t.) Virtually then, more than two thirds of the working population (with access), don’t do 401(k)’s?

 

Know Thy “K”

 

While I often resist approaching this subject at the risk of “beating a dead horse”, it is now crystal clear; the horse is nowhere near the end of its days. Next question: Why isn’t the majority of the working population taking advantage of this benefit?

 

After much consideration, my ventured guess is this: employees opt out because there is a lack of true understanding for the machinations of 401(k) plans, benefits of participation, and costs. Of these, perceived cost may be the biggest stumbling block.

 

Deductions & Reductions

 

Deductions taken from your pay check will reduce your take home pay, but it will not reduce it in the dollar for dollar manner many assume. Because these employee contributions are made on a pretax basis, any amount contributed to the plan will reduce your taxable income. Therefore, every dollar contributed to a 401(k) will result in a reduction in take home pay of 72 cents for an employee in the 28% Federal Income Tax bracket: $1.00 – $ .28 = $ .72. Think about how that multiplies.

 

Many states will also compute their income taxes based on this adjusted figure. In Illinois, if you are in a 28% Federal Tax bracket and the 5% State Tax bracket, the true cost of your dollar contribution would be 67 cents. ($1.00 – $ .28 – $ .05 = $ .67.) Federal Tax Credits available to lower income people may reduce these relative costs even further.

 

Market Ease

 

I also believe many people opt out because they don’t understand the markets, how to invest, or much of anything having to do with finances. While that used to be a somewhat valid excuse, modern day benefit management methods are proving otherwise.

 

Investment programs have become much more automated than they used to be. Most plans now offer portfolio programs professionally managed to selected specifications. For example,  the direction of your plan can be focused on the actual target date you have in mind to begin withdrawing funds when you retire.

 

Current benefit management systems take the task of portfolio construction out of your hands and into those of professionals who balance risk and reward within the elected set of demographics. The days of having to select individual market accounts and balancing them yourself are over.

 

Deferred Advantage

 

In addition to paycheck reductions and managed assistance, another major benefit of 401(k) plans is tax deferrals.

 

All growth in these products is deferred until they are withdrawn from the account. Therefore, if you contribute $3000 per year for thirty years, a total contribution of $90,000 would have been made. If the account balance is $500,000 after this time, none of the additional $410,000 would have been taxed as it was growing.

 

Keep in mind these funds will become federally taxable as ordinary income in retirement. State treatment of retirement income varies; Illinois does not tax retirement income from 401(k)’s.

 

Bonus Benefit

 

Because most people are in a higher tax bracket while working than they are in retirement, 401(k) participation is even more beneficial.

 

Contributions for participants who fall into this norm will: allow deductions from taxable income at a relatively higher tax rate and have receipt in retirement at a relatively lower tax rate. Ultimately, you’ll be paying less tax on the income you earned.

 

One Final Nay

 

Take advantage of employer match plans! (I.e. When employers offer matching contributions to your fund when you elect to participate.) Not taking advantage of this is literally passing up free money. Opt in now and cash in later!

 

Kurt Rusch  CLU, ChFC