Strategies for Maximizing After-Tax Wealth Creation - PowerPoint by zgo16864


									Strategies for Maximizing
After-Tax Wealth Creation

        NAPFA National 2007
        May 4, 2007
        Cheryl R. Holland, CFP®

Tax-Deferred Savings
  Non-deductible IRAs and Roth IRAs

  Roth 401(k)s/403(b)s

    Partnerships/LLC/Sole Proprietorships
    Subchapter S/C Corporation

  Roth Conversions
    Annual opportunities

  Funding IRAs at the first of the year

                         Tax Deferred Savings
                         Non-Deductible IRAs
                                          Value of Taxable Account (Ordinary Income Only)
                                          Value of Taxable Account (Capital Gain Only)
                                          Value of Tax-Deferred Account

End Value After Taxes




                                            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


                                                    Payment at End of Period
                                                    Payment at Beginning of Period

Final Value





                            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

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
    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.
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.
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
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.
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.
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

    Sample Tax Letter – Page 2

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.
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.
We have enclosed a printout of your taxable sales for the year that provides cost basis and acquisition
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.
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.
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.
We are enclosing a report documenting the margin interest paid on your taxable accounts in 2006.

  Sample Tax Letter – Page 3

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, 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.
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

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
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%

           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 =


                                                                                                                     Ending Wealth =
Strategy 2: Stocks in IRA                          IRA, $3,521,930                 Taxable, $1,403,397

                            $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
                       Harbor International
                       DFA Emerging Markets
                       DFA International Small-Cap
                       DFA Two-Year Global Bond
                       DFA Microcap
                       Royce Microcap
                       Calamos Growth and Income
                       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

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







         0.04          Vanguard Intermediate Tax Exempt

                       Vanguard Intermediate Bond
                       Tax Equivalent Yield of Vanguard T/E @ 25% MTB

                1996        1997          1998            1999          2000          2001   2002   2003   2004   2005

        Managing the Tax Drag on Portfolios
        Money Market Fund Selection

        4.5%                 Vanguard Prime Money Mrkt

                             Vanguard U.S. Treasury Money Mrkt
                             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






               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

   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%

                 Managing the Tax Drag on Portfolios

                 Calculating and Reviewing tax drag as a benchmark

               2000           2001           2002             2003              2004            2005             2006

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

$               8,912.00       4,487.28      2873.22          1,509.20            8,103.60      9,154.93         30,040.00
%                 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.

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

Nickels and Dimes

Capitalizing Investment Advisor Fees
   Mr. and Mrs. Client
   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

   '@@ - 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.
Concentrated Positions
    – Diversifying a portfolio
    – Providing a temporary hedge against a price decline
    – Monetizing the position to provide liquidity for other

   Separate Account Workout, e.g. Parametric

   Charitable Remainder Unitrusts/Foundations

   Exchange Funds

   Equity Collars and Protective Puts

   Gift to charity

   Limit Orders

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

                              Equity      Moderate C lient      Moderate Loan           Greater       Moderate                 Lesser            Moderate Under

                              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
(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.

“Don’t let the tax tail
 wag the dog”


   FPA Journal – Asset Location: A Generic Framework for
   Maximizing After-Tax Wealth. Daryanani, Gobind, Ph.D.,
   and Chris Cordaro.

   Morningstar, Inc. Morningstar Principia – Advanced

   Schwab Institutional. Market Knowledge Tools -
   “Investment Strategies to Reduce the Risk of Concentrated
   Positions.” 529 website.

   Investing with a Tax-Efficient Eye. Robert Gordon. CFA
   Institute Conference Proceedings.

   Ed Slott’s IRA Advisor. 1-800-663-1340.


   Gardner, Randy. “Recent Developments Help Avoid the
       Double Tax on IRD Property.” Journal of Financial
       Planning. February 2007.

   Reiner, Eric L. “A Sly Deduction.” Wealth Manager. March

   Slott, Ed. “NUA No-No’s.” Financial Planning. July 2006.

   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.


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