Get documents about "Strategies for Maximizing After-Tax Wealth Creation - PowerPoint
Document Sample
Strategies for Maximizing
After-Tax Wealth Creation
NAPFA National 2007
May 4, 2007
Cheryl R. Holland, CFP®
1
Tax-Deferred Savings
Non-deductible IRAs and Roth IRAs
Roth 401(k)s/403(b)s
Children
Partnerships/LLC/Sole Proprietorships
Subchapter S/C Corporation
Roth Conversions
2010
Annual opportunities
Funding IRAs at the first of the year
2
Tax Deferred Savings
Non-Deductible IRAs
$150,000
Value of Taxable Account (Ordinary Income Only)
Value of Taxable Account (Capital Gain Only)
Value of Tax-Deferred Account
$125,000
$100,000
End Value After Taxes
$75,000
$50,000
$25,000
$0
1 year 10 years 20 years 30 years
Assumptions: 9% return, 18% capital gains rate, 40.26% ordinary income tax rate 3
Tax Deferred Savings
Funding IRAs and 401(k)s at the first of the year
$450,000.00
$400,000.00
$350,000.00
Payment at End of Period
Payment at Beginning of Period
$300,000.00
$250,000.00
Final Value
$200,000.00
$150,000.00
$100,000.00
$50,000.00
$0.00
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30
Years Invested
$4000 invested annually at 7% growth rate 4
Tax-Deferred Savings
Funding 529 Future plans
State income tax deduction
Harvesting losses
Health Savings Accounts
Tax Relief and Health Care Act 2007
1035 Exchange
Life insurance to an annuity
Annuity to annuity and withdraw
5
Capturing efficiencies in delivering tax planning
advice – Knowledge Management
Automate processes
Income tax letters
Requesting returns
Reviewing returns
Charitable gift of appreciated securities
Leverage technology
Paperless exchange of returns
OCR returns
Extract key data points to CRM
Create checklists
Income Tax Return Review
Income Tax Planning meeting
6
Sample Income Tax Letter
February 1, 2007
Mr. and Mrs. John Client
1000 Devine Street
Irmo, SC 29063-9238
Dear John and Jane:
The purpose of this letter is to assist you with gathering information for the preparation of your 2006
income tax returns.
1099s
The purpose of this letter is to assist you with gathering information for the preparation of your 2006
income tax returns. According to our records, you will receive 1099s from Charles Schwab and
Company, Inc with a projected mailing date of January 31st. If you do not have this information in hand
shortly after this mailing date, please contact us. We will assist you in locating any missing forms.
1099-R
You may receive a 1099-R related to the rollover of the 401(k) account. We are enclosing
documentation to provide to your CPA reflecting the deposit of this rollover amount in your IRA Rollover
account.
SURRENDER OF LIFE INSURANCE POLICY
Jane surrendered a life insurance policy with New York Life in 2006. The taxable gain on this policy
should be on the 1099 from New York Life. If not, we can assist you in documenting this information.
INDIVIDUAL RETIREMENT ACCOUNT CONTRIBUTIONS
You each made a $4,000 non-deductible contribution to an IRA for the 2006 tax year. Please be aware
that Form 8606 needs to be filed for these nondeductible contributions.
John made a $4,000 contribution to a Roth IRA for the 2006 tax year.
Jane made a $4,000 contribution to a Roth IRA for the 2006 tax year. As you are aware there are
income limitations on the ability to fund a Roth IRA. If your adjusted gross income is too high, you will
begin to lose the ability to fund this Roth IRA. If this occurs, let us know so we may take corrective
action and reclassify this contribution.
CHARITABLE GIFT OF APPRECIATED SECURITIES
You made a gift of 150 shares of Pfizer for which we do not have the cost basis to Central Carolina
Community Foundation. The value of the gift for income tax purposes will be on the statement provided
by the charitable organization. Please provide this information to Kris when completing his tax
organizer.
7
Sample Tax Letter – Page 2
MEDICAL EXPENSES
Please be aware that the amounts you pay for your long-term care insurance are deductible as a
medical expense on your Schedule A within certain constraints. The premiums paid for the year should
be provided to your CPA.
TRUST DISTRIBUTIONS
Because you are the beneficiary of a Generation Skipping/Credit Shelter/…. Trust, we have enclosed a
distributions report for tax-year and a Portfolio Statement as of the end of the tax-year. If we have
omitted any items that may be needed for preparation of this return, please have your CPA call me and
we will be happy to provide the needed data.
REALIZED GAINS/LOSSES
We have enclosed a printout of your taxable sales for the year that provides cost basis and acquisition
information.
You will note there are a number of investments with an acquisition date of January 1, 1985. We do
have the cost basis for these purchases but not exact acquisition dates for all blocks. Thus, January 1,
1985, is just a placeholder and is accurate for income tax reporting purposes.
GIFT TAX RETURN
During the 2006 tax year you made annual exclusion gifts to family members. We have provided this
information to David Sojourner so that he may determine whether to file a gift tax return.
SOUTH CAROLINA 529 PLAN
During the year, you contributed $5,000 to the South Carolina 529 Plan. This contribution will reduce
your taxable income on the South Carolina return and therefore your South Carolina tax liability. You
should have a statement from the Future Scholar program reflecting your contributions for 2006 which
you will need to include in your tax preparation package for your CPA.
MARGIN INTEREST
We are enclosing a report documenting the margin interest paid on your taxable accounts in 2006.
8
Sample Tax Letter – Page 3
MONEY MARKET INTEREST—PORTION ATTRIBUTABLE TO U.S. SECURITIES OR SOUTH
CAROLINA MUNICIPAL BONDS
The money market managers will not be able to provide this information until late February. Once we
have received the information, we will post it on the Abacus Planning Group website,
www.abacusplanninggroup.com. If you will navigate to Strategic Partners and select Certified Public
Accountants, you will be able to retrieve this information for all Charles Schwab and Company and
Vanguard Group money markets and bond funds.
REQUEST FOR FEDERAL AND STATE RETURN
We hope this information is helpful. Please let us know if we can provide you or any additional
information in preparing your income taxes. When your income taxes are completed, please make sure
we receive a copy for our files.
Sincerely yours,
Cheryl R. Holland
cc: CPA
9
Managing the Tax Drag on Portfolios
Mutual fund selection issues
Exchange Traded Funds
Asset location decisions
Marginal Tax Bracket and Investment Decisions
Money Market Fund Selection
Tax Loss Harvesting
Calculating and reviewing the tax drag on a portfolio
as a benchmark
10
Managing the Tax Drag on Portfolios
Mutual Fund Selection Issues
Fund Name Turnover Ratio Potential Cap Gains Exposure
U.S. Large Capitalization Funds
DFA US Large Co 2% 12%
Amer Funds Amcap A 16% 19%
Fidelity Contrafund 64% 29%
SPDR Trust Series 1 2% 0%
Fidelity Magellan 6% 39%
International Large Capitalization Funds
DFA Large Cap Intl 1% 16%
Fidelity Overseas 79% 12%
Artisan International Inv 55% 14%
Harbor Intl Instl 12% 41%
U. S. Small Capitalization Funds
DFA U.S. Micro Cap 27% 33%
Royce Microcap 44% 28%
Schwab Small-Cap Eq Inv 118% 5%
Absolute Return Funds
Calamos Gr & Inc A 65% 17%
Gateway Fund 71% 9%
11
Managing the Tax Drag on Portfolios
Asset Allocation Decisions
Accum ulated Wealth Over 30 Years
Strategy 1: Bonds in IRA IRA, $1,512,680 Taxable, $3,598,385 Ending Wealth =
$5,111,064
IRA
Taxable
Ending Wealth =
Strategy 2: Stocks in IRA IRA, $3,521,930 Taxable, $1,403,397
$4,925,326
$0 $1,000,000 $2,000,000 $3,000,000 $4,000,000 $5,000,000 $6,000,000
Ordinary tax rate: 30%; Capital gains rate: 15%; Stocks pre-tax return: 8%; Bonds pre-tax return: 5%; Number of
years: 30; Amount in IRA: $500,000; Amount in taxable: $500,000
Source: Gobind Daryanani, Ph.D., CFP®, and Chris Cordaro, CFP® 12
Managing the Tax Drag on Portfolios
Asset Allocation Decisions
End-Wealth Differences for Baseline Case
IRA Factor Taxable Factor Difference
Real Estate [Public] 10.33 8.21 2.11
U.S. Large Stocks - Active 11.97 9.99 1.98
Commodities 5.29 4.45 0.83
U.S. Small Stocks - Active 14.24 13.51 0.73
Absolute Return 5.33 4.62 0.71
High-Yield Bonds 3.16 3.08 0.08
Emerging Markets 16.01 16.06 -0.05
International Large Stock 7.41 7.63 -0.22
Short-Term Bonds 1.26 1.59 -0.33
U.S. Large Stocks - Tax Efficient 6.8 8.6 -1.8
Source: Gobind Daryanani, Ph.D., CFP®, and Chris Cordaro, CFP® 13
Managing the Tax Drag on Portfolios
Mutual Fund Tax Efficiency
Tax Efficient Vanguard Limited Term Tax-Exempt Taxable Accounts
DFA US Large Company
DFA Large-Cap Value
Artisan International
DFA International Large-Cap
Gateway
Harbor International
DFA Emerging Markets
DFA International Small-Cap
DFA Two-Year Global Bond
DFA Microcap
Royce Microcap
Calamos Growth and Income
Merger
PIMCO Foreign Bond
DFA Real Estate Securities
PIMCO Total Return
PIMCO Diversified Income
Cohen and Steers International Realty
Tax Inefficient PIMCO Commodity Real Return Tax-Deffered Accounts
14
Managing the Tax Drag on Portfolios
Asset Location Decisions
Diff-Located $5,485,881
Stocks-In $5,208,722
Bonds-In $5,035,322
Pro-Rata $5,118,229
$4,800,000 $5,000,000 $5,200,000 $5,400,000 $5,600,000
Comparison of Location Strategies for Baseline Case
Straight-Line Analyses with Annual Rebalancing
Start AT End Return
Pro-Rata $1,000,000 $5,118,229 5.59%
Bonds-In $1,000,000 $5,035,322 5.54%
Stocks-In $1,000,000 $5,208,722 5.66%
Diff-Located $1,000,000 $5,485,881 5.84%
Source: Gobind Daryanani, Ph.D., CFP®, and Chris Cordaro, CFP® 15
Managing the Tax Drag on Portfolios
Marginal Tax Bracket and Investment Decisions
0.075
0.07
0.065
0.06
0.055
Yield
0.05
0.045
0.04 Vanguard Intermediate Tax Exempt
Vanguard Intermediate Bond
0.035
Tax Equivalent Yield of Vanguard T/E @ 25% MTB
0.03
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Year
16
Managing the Tax Drag on Portfolios
Money Market Fund Selection
5.0%
4.5% Vanguard Prime Money Mrkt
Vanguard U.S. Treasury Money Mrkt
4.0%
Vanguard U.S. Treasury Money Mrkt Tax Equivalent
yield @ 7% State Tax Bracket
3.5% Vanguard Tax Exempt Money Market
Vanguard Tax Exempt Money Market Tax Equivalent
3.0% yield @ 35% Marginal Tax Bracket
Yield
2.5%
2.0%
1.5%
1.0%
0.5%
0.0%
Jan- Feb- Mar- Apr- May- Jun- Jul- Aug- Sep- Oct- Nov- Dec- Jan- Feb- Mar- Apr- May- Jun- Jul- Aug- Sep- Oct- Nov- Dec-
04 04 04 04 04 04 04 04 04 04 04 04 05 05 05 05 05 05 05 05 05 05 05 05
Month
17
Money Market Rates
4/3/2007 4/10/2007
Schwab Value Advantage (SWVXX) 4.92% 4.92%
Schwab Advisor Cash Reserves (SWQXX) 4.71% 4.70%
Schwab Advisor Cash Reserves – Premier (SWZXX) 4.78% 4.77%
Schwab U.S. Treasury (SWUXX) 4.48% 4.49%
SC tax equivalent yield (assumes 7% SC income tax) 4.82% 4.83%
18
Managing the Tax Drag on Portfolios
Calculating and Reviewing tax drag as a benchmark
2000 2001 2002 2003 2004 2005 2006
12/31
Balance 1,782,484.63 1,793,206.00 1,613,031.51 2,174,410.81 2,506,263.98 2,774,222 3,162,105.12
Reduction
$ 8,912.00 4,487.28 2873.22 1,509.20 8,103.60 9,154.93 30,040.00
Reduction
% 0.50% 0.25% 0.18% 0.07% 0.32% 0.33% 0.95%
((Taxable interest plus non-qualifying dividends plus short term capital gains x MTB) +
(Ordinary qualifying dividends + net long term capital gains/loss x 18%)) ÷ 12/31 balance =
portfolio tax drag.
19
Nickels and Dimes
Income with Respect to the Decedent for IRAs and annuities
Capitalizing investment advisor fees
UBTI for IRAs and CRUTs
Deductibility of hedge fund fees
Investment Interest deduction
Charitable gift of appreciated assets or from IRA
Net Unrealized Appreciation
20
Nickels and Dimes
Capitalizing Investment Advisor Fees
Mr. and Mrs. Client
SECTION 266 CAPITALIZATION OF CARRYING COSTS
2004 Tax Return
Blue items require input. All others are calculated formulas (please do not input here). Please input the Financial Planning Fees as a negative number.
Total Current Year Fee $ 15,000.00
Financial Planning Fee (3,000.00) 100% deductible on Schedule A as miscellaneous deductions vs. capitalized in Schedule D.
Asset Management Fee $ 12,000.00 Allocated across accounts - partial deductible against taxable accounts/partial nondeductible against tax deferred accounts
ACCOUNT ACCOUNT GROSS ACCOUNT PRIOR YEAR CURRENT YEAR TOTAL TURNOVER DEDUCTIBLE REMAINING
BALANCE PROCEEDS BALANCE COST ALLOCATED FEES RATIO PORTION (1) 2005
12/31/2003 TOTAL 12/31/2004 CAP
Must put in account type as TD or TA for formulas to calculate properly
Tax Deferred Accounts:
SC 401 (k) TD 138,495 @@ 153,315 0 @@ 901 901 0 0 901
SC 457 TD 49,356 @@ 54,365 0 @@ 319 319 0 0 319
TIAA-CREF TD 103,163 @@ 106,239 0 @@ 624 624 0 0 624
Schwab Deductible IRA TD 100,597 @@ 111,736 0 @@ 657 657 0 0 657
Schwab Simple IRA TD 22,928 @@ 35,642 0 @@ 209 209 0 0 209
T. D. Waterhouse Roth IRA TD 7,180 @@ 6,683 0 @@ 39 39 0 0 39
Schwab Deductible IRA TD 44,078 @@ 49,968 0 @@ 294 294 0 0 294
Schwab Simple IRA TD 22,849 @@ 44,614 0 @@ 262 262 0 0 262
T. D. Waterhouse Roth IRA TD 7,048 @@ 6,552 0 @@ 38 38 0 0 38
Annuity TD 75,340 @@ 81,773 0 @@ 480 480 0 0 480
Taxable Accounts:
MAP, LP 2001 TA 50,000 50,000 0 294 294 0 0 294
Schwab One TA 164,120 98,967 211,919 0 1,245 1,245 0.46700429 581 664
Schwab Brokerage TA 424,414 493,579 0 2,900 2,900 0 0 2,900
Schwab Brokerage TA 74,410 30,764 86,135 0 506 506 0.357161292 181 325
Schwab CRUT TA 104,077 102,572 0 603 603 0 0 603
Schwab One TA 184,846 153,651 0 903 903 0 0 903
T.D. Waterhouse TA 277,317 293,606 0 1,725 1,725 0 0 1,725
South Financial Group TA 17,552 0 0 0 0 0 0 0
Total 1,867,771 0 2,042,348 0 12,000 12,000 762 11,238
Value Advantage 0
Value Advantage 0
129,731
'@@ - No allocation of fees to tax-deferred assets or real estate assets which pay a separate fee so no reason to input gross proceeds for these accounts.
(1) To be input as a separate line item on Schedule D as cost basis with zero sales proceeds. It may also be added with other sales.
21
Concentrated Positions
Goal
– Diversifying a portfolio
– Providing a temporary hedge against a price decline
– Monetizing the position to provide liquidity for other
needs
Separate Account Workout, e.g. Parametric
Charitable Remainder Unitrusts/Foundations
Exchange Funds
Equity Collars and Protective Puts
Gift to charity
Limit Orders
22
Concentrated Positions
INVESTOR OBJECTIVES
Hedge Management
Provide Downside Upside Position of Tax
Liquidity Diversification Risk Potential Exit Speed Liability
Immediate Greater Greater Proceeds Greater After Lesser Greater Lesser Gains
Sale Proceeds are are available for sale, portfolio is Position is Position is are immediately
immediately reinvestment no longer immediately immediately recognized
available impacted exited exited
Separate Moderate Moderate Greater Position Greater Price Greater Moderate Exit
Account Proceeds Proceeds from sales may be appreciation is Position is Strategy is
available as sales are reinvested in temporarily possible during gradually planned to
Workout are executed uncorrelated hedged during workout period exited balance potential
according to plan securities workout period if unhedged gain/loss and tax
consequences
Equity Moderate C lient Moderate Loan Greater Moderate Lesser Moderate Under
RISK MANAGEMENT STRATEGIES
Collar may borrow up to proceeds may be Price
Downside risk is Position may straddle rules,
50% of the reinvested appreciation is
limited to the put be disposed of gains on the put
position for limited to the
strike price for the the collar are realized and
reinvestment, call strike price
the duration fo is unwound deductions may
100% for other the contract for the duration be limited
purposes of the contract
Protective Moderate Still Lesser Greater Greater Moderate Moderate Gains
Put Options have the ability to Diversification can Provides investor Unlimited C an sell at are realized
sell position only be achieved by with downside minus cost of any point on upon disposition
above the strike borrowing cash protection. the option. the upside but of the position at
price but must against the hedged downside will expiration
pay for put position and expire at
option. revinvesting in strike price.
other securities.
Exchange Lesser A seven- Greater C lient Moderate Moderate Greater At Greater The
Fund year commitment receives share of Market exposure Market redemption exchange of
period is required diversified portfolio to a diversified exposure to a client receives shares is tax-
portfolio diversified a diversified free
portfolio portfolio
Charitable Moderate Greater Asset is Moderate Moderate Greater Greater
Remainder Provides income sold and proceeds Income stream Income stream Immediate Generates an
stream based on are reinvested in is affected by is affected by dispositon of immediate tax-
Trust the term of the diversified portfolio value of the value of the position deduction and
trust diversified diversified the assets are
portfolio portfolio excluded from
the donor's
estate for estate-
Source: Schwab Institutional tax purposes 23
Prudent Investor Act
(3) A trustee shall consider in investing and managing trust assets those
circumstances of the following as are relevant to the trust or its
beneficiaries:
(a) general economic conditions;
(b) the possible effect of inflation or deflation;
(c) the expected tax consequences of investment decisions or strategies;
(d) the role that each investment or course of action plays within the
overall trust portfolio, including financial assets, interests in closely held
enterprises, tangible and intangible personal property, and real property;
(e) the expected total return from income and the appreciation of capital;
(f) other resources of the beneficiaries;
(g) needs for liquidity, regularity of income, and preservation or
appreciation of capital; and
(h) an asset's special relationship or special value to the purposes of the
trust or to one or more of the beneficiaries.
24
“Don’t let the tax tail
wag the dog”
25
Bibliography
FPA Journal – Asset Location: A Generic Framework for
Maximizing After-Tax Wealth. Daryanani, Gobind, Ph.D.,
and Chris Cordaro. www.fpanet.org.
Morningstar, Inc. Morningstar Principia – Advanced
Analytics. www.morningstar.com
Schwab Institutional. Market Knowledge Tools -
“Investment Strategies to Reduce the Risk of Concentrated
Positions.”
www.savingforcollege.com. 529 website.
Investing with a Tax-Efficient Eye. Robert Gordon. CFA
Institute Conference Proceedings. www.cfapubs.org.
Ed Slott’s IRA Advisor. 1-800-663-1340.
26
Bibliography
www.foundationsource.com
Gardner, Randy. “Recent Developments Help Avoid the
Double Tax on IRD Property.” Journal of Financial
Planning. February 2007. www.fpanet.org.
Reiner, Eric L. “A Sly Deduction.” Wealth Manager. March
2007. www.wealthmanagermag.com
Slott, Ed. “NUA No-No’s.” Financial Planning. July 2006.
www.Financial-Planning.com
Strobel, Caroline and Paul Steer. “Proper Planning can Minimize the
Impact in Respect of a Decedent.” The Tax Advisor,Vol. 26,
No. 5, May 1995, pp.297-304
Swift, Marie. “A Round of Transitions.” Wealth Manager.
February 2007. www.wealthmanager.com
27
Related docs
