BOSTON – The Democrats are back in charge of Congess and in the majority of state capitols. And for some pundits and gurus, that means it's time to revisit one's retirement, estate and financial plans.
For most pre-retirees and retirees, the revisit will result in some minor tweaks here and there. For the wealthiest of Americans, especially those who face potentially big estate-tax bills come 2011, the revisit could result in some major overhauls.
"It's time to build flexibility into your plans," said Mark Nash, co-author of "PricewaterhouseCooper's 2007 Guide to Tax and Financial Planning."
No matter whether one is wealthy or just average, experts say that Americans will have more than enough time to make the changes to their plans. There are two reasons for that.
First, the Democrats, sensing that they could take control of the White House in 2008, won't propose drastic changes to ordinary income tax rates, or the alternative minimum tax or even estate tax rates over the next two years. Doing so, would put at risk their chances for having a Democrat as President in two years.
Second, Stephen McKee, president of Investment Selections & Timing says having Democrats in control the House and Senate and the Republicans in control the White House will result only in gridlock. "Don't let a Congress shift wag the investment dog, unless and until major changes are enacted," he said.
So what changes should average and wealthy Americans make over the next two years?
Roth IRA conversion
If ordinary income tax rates rise in the future — say after 2008 — then Roth IRAs start to look like a golden goose. Robert Keebler of accounting and consulting firm Virchow, Krause & Co., said retirees and preretirees should all plan on contributing to Roth IRAs or Roth 401(k)s and they should plan on converting either now or when eligible their traditional IRAs into Roth IRAs.
Experts like Roth IRAs because unlike traditional IRAs there are no required minimum distributions. And unlike traditional IRAs, distributions from Roth IRAs are not taxed.
At present, Americans, single or married, with modified adjusted gross incomes of less than $100,000 can covert their traditional IRA into a Roth IRA, according to Nash. But come 2010, Nash said Uncle Sam will remove the $100,000 ceiling on modified adjusted gross income and all taxpayers will be able to convert their traditional IRAs to Roth IRAs if they desire.
What's more, taxpayers can spread the income from Roth IRA conversions done in 2010 over tax years 2011 and 2012. Taxpayers who convert traditional IRAs to a Roth IRA do have to pay income tax on the amount converted, but they don't have to pay the 10 percent penalty that applies to early IRA withdrawals.
Reduce taxable estates
At present, experts say it's unlikely that the estate tax will be repealed or even reformed anytime soon. "I think there will be no action or deadlock on estate tax reform/repeal until after 2008," said Michael Jones of Thompson Jones.
Under current law, a federal estate tax is due on estates worth more than $2 million for those dying in 2006, 2007 or 2008. A federal estate tax will be due on estates worth more than $3.5 million for those dying in 2009. The federal estate tax will be repealed in 2010 and, come 2011, a federal estate tax will be due on estates worth more than $1 million.
Of note, the federal maximum tax rates will fall from 46 percent this year to 45 percent in 2007, 2008, and 2009. The tax rate is repealed in 2010 and then returns to 55 percent in 2011.
Nash, for his part, expects Congress to increase at some point the amount exempt from federal estate taxes to $5 million per person as proposed by then House Ways and Means Committee Chairman Bill Thomas, R-Calif., in H.R. 5638 and Keebler says federal estate tax watchers should explore the Joint Committee on Taxation's Web site to get a sense of potential changes.
Unsure what the future ultimately holds, however, both Keebler and Nash says taxpayers should continue if not accelerate their efforts to reduce their taxable estates. "Americans should take advantage of current rules," said Nash, who recommends that taxpayers start by reviewing their wills and how their property is owned.
Gifting and the annual exclusion
Taxpayers can this year and next transfer $12,000 ($24,000 for most married couples) to each of an unlimited number of individuals free of gift tax, according to Nash's book. Gifts beyond that are taxable, but only to the extent they exceed $1 million over a donor's life.
According to Nash, making annual gifts removes property from your estate at no gift or estate tax cost and often shifts income-earning property to family members in lower-income tax brackets. What's more, future appreciation in the value of gifted property is also removed from your estate.
In addition to the $12,000 annual exclusion, Nash's book notes that there is an unlimited exclusion for any tuition you pay directly to a school or for medical-care payments you pay directly to a health-care provider on someone else's behalf.
In addition, the Pension Protection Act of 2006 allows IRA owners age 70 1/2 or older to make direct transfers of up to $100,000 per year from their IRA to a charity. The provision became available for IRA distributions taken after Aug. 17, 2006 and applies only through the end of 2007. Read more.
Estate planning for the wealthy
Keebler and Nash say Americans, or at least those with worth $3 million and more, should become much more aggressive, should accelerate their use of the following estate planning tools and techniques:
Use valuation discounts. According to Nash's book, transfers of certain types of assets, typically a minority interest in a business, may permit the use of a valuation discount for gift and estate tax purposes. Consider trusts. According to Nash, married couples should have a credit shelter or family trust in their estate plan if the combined assets exceed the estate tax exemption amount of $2 million in 2006. In addition, Nash suggests the use of life instance trusts as a way to shelter the proceeds from a life insurance policy from estate taxes. And Keebler suggests the use of a grantor retained annuity trust. That's a trust in which a person puts property expected to appreciate, such as S corporation stock or publicly traded stock, into the trust but keeps the initial value of the investment and earns a fixed return. In addition, Keebler recommends the use of something called a dynasty trust. That's a trust that lets you set aside assets for the benefit of grandchildren and great-grandchildren without incurring gift, estate or generation-skipping transfer taxes.
Here's a roundup of planning strategies:
Review your will and estate plan to determine what adjustments are needed to benefit from changes to the estate and gift tax and to avoid potentially costly pitfalls. Especially consider whether you need to change or eliminate an existing credit shelter trust arrangement. Use asset ownership forms that maximize estate tax savings, for instance limited liability companies or limited partnerships.
Review the use of joint ownership. Make sure each spouse has enough assets in his or her own name to fund credit shelter trusts or other testamentary objectives.
Make annual exclusion gifts each year ($12,000 per donee in 2006). Gift appreciated capital assets to children and grandchildren in the lower income tax brackets so they will be liable for only a 5 percent income tax on the recognition of long-term capital gain (however, beware of the kiddie tax rules)
Pay tuition expenses directly to an educational institution or make a payment to a health-care provider on behalf of a donee. Consider a multiyear tuition gift, where appropriate.
Transfer existing life insurance policies into a life insurance trust. Acquire any new life insurance policies within a life insurance trust.
Put rapidly appreciating assets into grantor retained annuity trust or sell them to an intentionally defective trust. Reconsider the investment mix of trust assets to take advantage of lower dividend and capital gain tax rates. Structure asset ownership to take advantage of valuation discounts.
Source: PricewaterhouseCoopers 2007 Guide to Tax and Financial Planning
Copyright (c) 2006 MarketWatch, Inc.