Financial Abundance Guide

Would you like to discover a way to reduce your 2008 taxes? Funding an IRA between now and April 15 is one of the few remaining methods to reduce last year’s taxable income. Let’s look at three popular IRAs to determine if a year-end contribution is appropriate for you.

For someone who is self-employed, a SEP IRA is often the best way to reduce your taxable income and save for retirement. If your company is an S or C Corporation, you can contribute up to 25% of your W-2 income to a SEP IRA. With a sole proprietorship or an LLC your maximum contribution is 20% of your income. In either case, the maximum annual contribution is $46,000 for 2008.

If you have any employees, you must contribute the same percentage of income for any employee that is over 21, has worked for you for at least 3 years and receives at least $550 in annual compensation.

If you have no self employment income, you may be able to contribute to a traditional, deductible IRA or to a Roth IRA. To determine if you qualify for an IRA contribution, let’s look at the rules for each type of IRA.

To contribute to a traditional IRA, you must be under 70½ years old and you(or your spouse) must have earned income. In 2008, your maximum IRA contribution is $5,000 ($6,000 if you are over age 50).

If you are covered by a company retirement plan, you can deduct the maximum amount when your Adjusted Gross Income (AGI) is no more than $53,000 as a single tax payer or $85,000 as a joint filer. If your spouse has no earned income, they can contribute the maximum amounts to their own IRA, even when you are covered by a company retirement plan, as long as your AGI is under $159,000.

To contribute to a Roth IRA, your Adjusted Gross Income (AGI) must be less than $101,000 as a single filer or $159,000 as a joint tax filer. Your maximum Roth IRA contribution is $5,000 ($6,000 if you are over age 50). However, if you make any traditional IRA contributions, the maximum Roth contribution amount is reduced by the amount that you contributed to the traditional IRA.

Based on IRS rules, the decision on which IRA to fund is often obvious:

1. If you are not covered by a company retirement plan and, as a single filer have an AGI over $101,000 or as a joint filer have an AGI over $159,000, you can only fund a traditional IRA.

2. If you are covered by a company retirement plan and your AGI is over $85,000 but less than $159,000 as a joint filer or over $53,000 but less than $101,000 as a single filer, you can only fully fund a Roth IRA.

3. If you are over 70½ and have earned income, you can only fund a Roth IRA.

Funding a Roth IRA has the following advantages over a traditional IRA:

1. When buying your first home, a Roth IRA allows the withdrawal $10,000 of growth and income plus all of your contributions, with no taxes or penalties on the withdrawal.

2. For people under age 40, the tax free growth and withdrawal of funds during retirement often make Roth IRA contributions a better, after-tax choice.

3. When funds are required before age 59½, a Roth IRA typically allows the withdrawal of Roth contributions with no taxes or penalties on the withdrawal.

4. A Roth IRA in your estate is an excellent method of passing tax free funds to younger generations.

If there are no compelling reasons to chose a Roth over a traditional IRA, decide on whether you wish to reduce your current taxes with a traditional IRA or reduce your taxes during retirement with a Roth IRA.

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In early December, I made sure that all of my asset management clients received a Christmas present. However, they will not be able to open it until April 15. In this article, I will show you how to give yourself the same present, which could be worth $1,000 or more.

I am not aware of any investor who has not suffered substantial losses in 2008. The one bright side of investing losses, is that up to $3000 in net capital losses can be deducted from your 2008 taxes. If you are in the 28% federal tax bracket and the 5% state bracket, your total tax savings would be approximately $1,000. The savings is even more if you are in a higher tax bracket.

Many investors are buy and hold investors. While this investing approach defers capital gains taxes when markets are up, strict adherence to such an approach could cost you tax dollars in 2008. Here is a simple way give yourself a 2008 tax reduction.

For each of your taxable brokerage accounts, go on-line or call your broker to determine what your realized capital gains/losses are for 2008. If your realized capital losses, in all of your taxable accounts, is greater than $3,000, no further action is required. However, if you have realized capital gains in these accounts, you must take some action.

Review your taxable portfolio to determine which stocks or mutual funds are are most concerning. Pick one or more of these assets and determine its unrealized capital loss. If this loss is at least $3,000 more than your current realized gains, sell it by December 31 to claim your $3,000 tax loss. If your loss is still not at least $3,000, pick your next least favorite stock or mutual fund, until you have at least a $3,000 net loss.

If you own mutual funds, immediately call each fund company to determine if they will be making a capital gain distribution in 2008. Even though virtually all mutual funds are down in 2008, some will be adding insult to injury with the requirement that they pay out all capital gains by the end of the year. If your fund will pay out capital gains, either sell it or be sure to include the capital gains amounts in the above calculations.

If you want to maintain your current asset allocation after you sell a stock or mutual fund, look for a similar type of stock or fund with better financial prospects in 2009 and beyond. While I never recommend that investors make investment decisions strictly on the basis of tax savings, now is the time to take a close look at your investment portfolio. You will be a fairly unique investor if none of your stocks or mutual funds are of concern in 2009 and beyond.

If this strategy makes sense to you, I hope that you enjoy this Christmas present, even if you have to wait until April to open it.

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For most of us, 2008 has not been a good year for our finances. One way to maximize your financial abundance is to avoid paying more in taxes than you should. With the end of 2008 rapidly approaching, let’s look at some actions that can lower the amount of taxes that you will owe on April 15, 2009.

1. Capital Loss Deduction – If you have any investments in taxable accounts, you likely have unrealized capital losses in 2008. Before year end, determine if you have realized any capital gains for 2008. If you have not sold any investments at a loss this year, it may be wise to sell enough to assure that your net realized capital losses are at least $3,000 in 2008. This $3,000 loss can be used to offset other income that you report for 2008.

2. Mutual Fund Capital Gains – With the markets off 40%, you might think that you will receive no capital gain distributions from your mutual funds in 2008. However, many mutual funds will be making a capital gain distribution in December. If you have mutual funds in your taxable accounts, call the mutual fund company and ask if they expect to make a capital gain distribution. If so, either sell the fund before the distribution date or be sure you have other capital losses to offset any gains received.

3. 401(k) and 403(b) Plans – Maximize your 401(k) and 403(b) contributions before year end. The maximum tax deductible contribution for each plan is $15,500 in 2008. However, if you are over 50 you may make a “catch up” contribution of an additional $5,000 for a total of $20,500. If it is too late to do this for 2008, be sure to sign up for the maximum reduction that you can afford in 2009.

4. Roth IRA Conversions – If your modified Adjusted Gross Income (AGI) for 2008 will be less than $100,000, you are eligible to convert your current IRA holdings into a Roth IRA. Roth IRA funds will remain tax free for both your lifetime and the lifetime of your beneficiaries. While you will be required to pay taxes on the amount converted, with the markets down, this may be an ideal time to convert. Check with your financial advisor or CPA to see if this is an appropriate strategy for you.

5. Charitable Gifts – In rough financial times, it is often hard to remember that many people are experiencing much worse financial pain than we are. If you are inclined to help those less fortunate than yourself, charitable giving can also help reduce your taxes. If you give away items, be sure that all items are in at least “good” condition. Also, keep a detailed list of the items, their condition and the thrift store value of each item. If you have a required IRA distribution that you must take by year end, consider a direct rollover of the amount required to your favorite charitable organization.

6. Donor Advised Funds – If you are going to provide cash charitable gifts in 2008, you might consider setting up a Donor Advised Fund. If you have long term capital assets which have appreciated since you purchased them, you can donate the asset to a Donor Advised Fund account and receive a deduction for the full value of the long term asset. Not only do you get this charitable tax deduction, you will never pay taxes on your capital gains.

7. Year End Gifts – For people with large estates who are worried about eventual “death (estate) taxes” you can annually give up to $12,000 ($24,000 for a couple) to any individual. For a wealthy couple with 3 children and 7 grandchildren, $240,000 can be removed from their taxable estate every year. While this saves no current year taxes, it could substantially reduce eventual estate taxes.

There are other methods of reducing your 2008 taxes which do not require action by the end of the year. These will be addressed future articles. If any of the above ideas apply to you, do not procrastinate. If you do not complete these actions before December 31, you will not be able to use them in 2008.

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With inflation exceeding 5%, are you searching for ways to cut expenses and save for retirement? While often overlooked, the Health Savings Account (HSA) can significantly lower your health care costs and provide a tax-free way to save for retirement.

For you health insurance needs, you should consider the combination of a High Deductible Health Plan (HDHP) with an HSA. These health insurance plans are often undersold by insurance agents due to the lower commissions they receive. However, when compared to a traditional health insurance plan, the HDHP/HSA combination will virtually always reduce your health care costs.

The HDHP/HSA combination is often characterized as only being advantageous for the healthy and the wealthy. This assertion is wrong! As long as you contribute the maximum annual amount to your HSA, the HDHP will virtually always save you money on your health care costs, regardless of your health care expenses.

An HDHP/HSA provides three financial advantages over a traditional health insurance policy:

1) If a traditional health care plan, with a $1,500 family deductible, costs $400 per month, an HDHP, with a $4,000 family deductible, will typically cost around 25% less or $300 per month. In this example, the HDHP provides a $1200 per year savings on insurance premiums.

2) When you contribute the family maximum to your HSA, a $5,800 tax deduction is applied to both federal and Colorado income taxes. If family taxable income exceeds $65,100, all incremental income is taxed at 25% for federal income taxes and 4.63% for Colorado state income taxes. The $5,800 maximum HSA deduction provides a combined federal and state income tax savings of $1,718.50.

3) Medical expenses paid from your HSA are made with tax-free dollars. With a traditional health plan, all expenses are paid in after tax dollars. Thus, paying the traditional plan’s $1,500 family deductible will require before tax earnings of $2,132.

Let’s assume that your health care costs exceed $4,000 in 2008. On an after tax basis, the traditional health insurance plan’s deductible will save you $1,868 over the $4,000 HSA deductible. However, HDHP premiums are $1,200 less and the HSA deposit saves you $1,718.50 in federal and state income taxes. Combining both the premium and income tax savings, the HDHP/HSA plan costs $1050.50 less than a traditional health insurance plan, at the maximum HDHP deductible amount of $4,000. HDHP plans also have no co-pays and often pay 100% of all medical expenses after the deductible is met.

If your family is healthy and you only require $1,000 in medical expenses for the year, the annual after tax savings with the HDHP is $3,340. This represents the sum of the HDHP insurance premium savings, the HSA income tax savings and $421 saved by paying the $1,000 in medical expenses with HSA funds that are never taxed.

An HSA is the only savings device that combines the income tax savings of an IRA with the tax free withdrawal of a Roth IRA. Like an IRA, funds deposited into an HSA are completely deductible from your income taxes, even if you don’t itemize. Like a Roth IRA, HSA funds can be withdrawn tax free at any time, to pay for medical expenses.

If your finances will allow, use current income to pay medical expenses and save your HSA funds until retirement. The Employee Benefit Research Institute estimates that a 65 year old will require $164,000 in medical expenses if they live 20 years after retirement. With HSA funds growing tax free, you could potentially have “free” medical care throughout your retirement years.

As long as you fully fund your HSA account and are in at least the 25% federal income tax bracket, you will virtually always come out ahead with the HDHP/HSA. When it comes time to renew your health insurance coverage, consider the HDHP/HSA approach. It will save you money and it can provide an excellent savings vehicle for your retirement years.

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In the next few days you may be receiving a tax “rebate.” How are you going to spend it?

While our elected officials want you to go out and spend your rebate to help “stimulate” the economy, you might want to use it to begin to recession proof your life for the present as well as future recessions. If you would like to begin approaching life from abundance instead of scarcity, here are some possible ways to “spend” your rebate.

1. Use it to pay off your credit card debt, one of the most expensive forms of debt available.

2. Begin funding your “emergency fund.” An emergency fund is a highly liquid account which provides coverage for between six months to one year of your current expenditures. This fund will allow you to survive a business downturn, job loss or short- term disability without invading your retirement accounts.

3. If you are saving for a first house, use it to fund a Roth IRA. Even if you have a company retirement plan, you can contribute up to $5,000 annually to a Roth IRA, if you are single and earn less than $101,000 or earn less than $159,000 if you file taxes jointly. Once your Roth IRA has been established for five years, you pay no taxes when withdrawing up to $10,000 of Roth income plus all of your Roth contributions for a down payment on your first house.

4. If your employer provides matching funds to your company retirement plan contribution, use it to contribute up to the maximum amount that your employer matches. The matching funds are “free money” that virtually guarantee you a high rate of return.

5. If you have children that will one day go to college, use it to fund a Coverdell Education Savings Plans or a Section 529 College Savings Plans. With both plans, the invested funds will grow tax free and can be withdrawn tax free when used for educational expenses.

6. Invest it in either an IRA or Roth IRA for retirement. In future posts, I will demonstrate how you can never have too much for retirement.

You have probably heard the expression “use it or lose it.” If you spend the rebate buying another “thing” you will lose it. If you put it to work for you in one of the ways listed above, you will use it now and in the future.

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Yesterday was the deadline to pay your 2007 taxes. If you are like most people, you probably feel that you paid too much. If so, now is the time to identify ways to lower your 2008 taxes. Every dollar of reduced taxes can be used to help fund educational or retirement expenses.

In “Financial Abundance Guide” I devote almost 100 pages to strategies for reducing your taxes. To demonstrate that I “eat my own cooking,” I will describe the approaches to tax reduction that my wife and I used in 2007. In parentheses I will put the page of my book on which the referenced strategy can be found.

1. In spite of receiving significant long term capital gains in 2007, we reported gains of less than $1,000 on our tax return. This was accomplished by keeping most of our equity holdings in our IRA or Roth IRA retirement accounts (pages 125 -126).

2. We were able to deduct $7,250 by fully funding our Health Savings Accounts (HSAs) in 2007. Since my wife and I are both over age 55, by setting up separate HSAs, we could each deduct an additional $800 over the normal family deduction of $5,650 (pages 63-66). In 2008, we will be able to contribute (and deduct) a total of $7,600 into our HSAs.

3.  Thanks to the expenses involved in writing, publishing and marketing my book in 2007, I had virtually no earned income. However, my wife had more than adequate income to allow for me to fund my IRA as a “spousal IRA” and receive a deduction of $5,000 (page 44-45). Since our AGI was under $159,000 my wife contributed $5,000 to a Roth IRA, even though she was covered by a company sponsored retirement plan (pages 46-47).

4. Our itemized deductions included a $10,000 gift to our “Donor Advised Fund” charitable giving account (pages 81-83). This was a gift of highly appreciated stock that we bought for $4,000 in 1999. By giving the stock to our charitable fund, the $6,000 capital gain was completely tax free, saving us from paying $900 in capital gains taxes (page 80-81).

5. Our daughter, in her third year of college, had tuition bills exceeding $8,000 in 2007. Thanks to the Lifetime Learning Credit, we received a $1,600 tax credit against actual taxes owed (page 38-39).

6. After all deductions and credits, our tax bill would have been $0. Knowing this was likely, I ran a pro forma tax return in early December. I determined that we could convert a significant amount of our IRA savings into a Roth IRA, and pay very little in taxes (pages 48-50). In December 2007, we converted $55,000 of IRA funds to Roth IRA funds. The total tax bill for this conversion was $2,605 for an effective tax rate of 4.7%. These funds can grow on a tax free basis for as long as we live. If we are able to leave an inheritance for our children, inherited Roth funds can continue to grow tax free for our children (page 176-177).

“Minimize your taxes” is Step 3 of the “7 Steps to Financial Abundance.” As I have demonstrated, active tax management can substantially increase your financial abundance. The next time that you are trying to maximize you investment returns, take a few minutes to consider methods of minimizing your taxes. The time spent may provide an “investment return” that far exceeds your expectations.

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Politicians, both Democrat and Republican continue to talk about the need to provide affordable health care for all Americans. However, by preparing your 2007 tax return and using Schedule A to itemize deductions, you get a first hand opportunity to witness the hypocrisy of our political class.

If politicians really wanted to reduce health care costs, their first act would be to remove the 7.5% of AGI deduction penalty for health care expenses. If you are married and your combined Adjusted Gross Income (AGI) is $100,000, your first $7,500 in medical expenses is not deductible from your taxes. Assuming that you are in the 25% federal tax bracket and pay a 5% state income tax rate, this “health care penalty” will cost you $2,250 in additional taxes. Eliminating this penalty would provide a 30% reduction in health care costs.

The political hypocrisy is even more evident when you consider that all of the mortgage interest that you pay for your house is deductible, but you cannot deduct most, if not all of your health care costs. If you agree that health care costs should get as least as favorable tax treatment as home mortgage costs, join me in contacting your representative to congress and your senators.

If politicians really want more affordable health care, they could easily take the first step by eliminating the “health care penalty” in our tax code.

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      While many opportunities to reduce your 2007 taxes ended on December 31, there may still be some last minute steps for lowering your taxes. If you qualify, taking the following actions by April 15 can reduce your current or future taxes.

1. Fund your IRA – If you are under 70 ½ years of age, have earned income and are not covered by a company retirement plan, you may contribute to a traditional IRA the lesser of your earned income amount or $4,000 ($5,000 if you are at least age 50). The IRA contribution is deducted from total income, which lowers your Adjusted Gross Income (AGI).

If you are in the 25% federal income tax bracket, your income tax savings (combining federal and state taxes) for a $4,000 contribution is almost $1,200. Since the after tax cost for this investment is approximately $2,800, you receive an immediate investment return of 42% on the $4,000 contribution.

Even with a company sponsored retirement plan, if Modified Adjusted Gross Income is under $52,000 ($83,000 for a joint tax filer), your IRA contribution is fully deductible.

2. Fund a Spousal IRA - Are you aware that if your spouse has no earned income, he/she can still contribute up to $4,000 ($5,000 if at least age 50) to an IRA for 2007?

With a Spousal IRA, if either spouse has earned income, both spouses may be able to fully fund a tax deductible IRA. Even if the income earner has a company sponsored retirement plan, the spouse may contribute to an IRA.

If the Modified Adjusted Gross Income (MAGI) on your joint tax return is less than $156,000, the Spousal IRA contribution is fully deductible. If you or your spouse has little or no income, be sure to fund a Spousal IRA.

All IRA contributions grow tax-free until your required withdrawals begin at age 70 ½. If you qualify, fund a traditional IRA by April 15.

3. Fund a Roth IRA – You may contribute $4,000 ($5,000 if at least age 50) to a Roth IRA for 2007, if your AGI is under $99,000 ($156,000 for a joint tax filer). However, the maximum contribution is reduced by any contribution that you make to a traditional IRA.

While funds contributed to a Roth IRA do not immediately reduce your taxes, the contributions will grow tax free and are not taxed when they are withdrawn.

If you hope to leave any assets for your kids, Roth IRAs are perfect. Your children can roll them into an inherited Roth IRA and make withdrawals based on their life expectancy. With this approach, Roth IRAs can provide decades of tax free growth.

If you are over age 70½ or you are covered by a company retirement plan and your MAGI is over $52,000 ($83,000 for a joint tax filer), you may only contribute to a Roth IRA. If you cannot fund a traditional IRA, but qualify for a Roth IRA, be sure to fund it by April 15.

4. Fund a Health Savings Account (HSA) – If you had a qualified High Deductible Health Plan (HDHP) throughout 2007, you can contribute $2,850 to an HSA for an individual health plan or $5,650 for a family plan. You may contribute an addition $800, if you are age 55 or over. For tax payers in the 25% tax bracket, the $5,650 HSA contribution costs only $3,975 after federal and state taxes, providing an immediate 42% investment return.

With an HSA, you may use funds to pay current medical bills or you can invest the funds for long-term, tax-free growth. By investing the HSA funds until retirement, you will have years of tax free growth and can withdraw all of the funds tax-free for medical expenses. The HSA funds could pay for most, if not all of your medical expenses during retirement.

Other savings plans that can be funded between now and April 15 include a SEP IRA, if you are self employed, and a Coverdell ESA for you children’s educational expenses. If you qualify for any of these plans, contributions by April 15 can save on taxes, either now or in the future.

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Congress recently approved the “economic stimulus package,” which will provide every single tax filer with adjusted gross income (AGI) of $75,000 or less with $600 and every joint filer with AGI under $150,000 with $1,200.  If you have dependent children, you get an additional $300 for each dependent child.

 The reason for this program is to get us to spend the funds to help “revive” the US economy.  From my perspective, the long term results of this program will not revive the economy, but will serve to put our country deeper in debt.

 As one pundit has stated, this should be called the China economic stimulus package.  Much of the $150 Billion of additional long term debt that this “stimulus” provides will likely be purchased by the Chinese or other foreign entities.  Thus, additional government resources (which come from you and me) will be required to service this debt.

 As an added benefit to China, if the money received is spent at WalMart, Target or other large retailer, it will be used to purchase goods that are manufactured in China, increasing our trade deficit.  Some “economic stimulus” this program turns out to be.

 OK- so our elected officials are scamming us in order to “buy” more votes – what else is new?  However, we can take this lemon and make it more palatable. 

 Here is what you might consider doing.  If you have any credit card debt, use the funds that you will receive to pay it off.  If you already pay off your credit card in full each month, take the money and use it to pay down some of your mortgage or put it in one of your savings accounts.  In 20 years, the $1,200 will be worth over $6,000, if your investments return 8% annually.

 We can never keep our elected officials from doing things harmful to our economy, but we can minimize the damage that they do.  I hope you will use this “stimulus” to increase your financial abundance.

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