Avoid the Tax Trap

Strategies to reduce your tax burden.

Federal taxes on estate and income

Financial Planning Can Optimize Your Tax Burden


When considering taxes, remember there are actually two Uncle Sams to contend with. There’s the familiar “Income Tax” Uncle Sam, and then there’s “Estate Tax” Uncle Sam when a legacy transfers to the next generation. Below are the major tools available to you to avoid falling into the retirement tax trap.


IRA (Individual Retirement Arrangement)


Yearly contributions to an IRA can be taken as a tax deduction. (Income Limits Apply) Growth in the account is tax-deferred, and all withdrawals are taxed at ordinary income rates, both Federal and State. Upon attaining age 70 ½, there will be a yearly mandatory withdrawal imposed, or “Required Minimum Distribution.” Failing to follow RMD guidelines exactly can result in severe penalties.


Roth IRA


Yearly contribution limits are the same as a Traditional IRA. However, there is no up-front tax deduction allowed. Qualified withdrawals from a ROTH IRA are generally Federal and State tax free. ROTH IRAs have no mandatory withdrawals at age 70 ½. Traditional IRAs can be converted to ROTH IRAs. ROTH IRAs and ROTH Conversions can be used to mitigate or eliminate the risk of higher tax rates in the future, and may also reduce taxes on Social Security Income. Consider a complete ROTH Conversion Analysis as a valuable part of your long-term planning.


401(k) ISD (In-Service Distribution)


Provisions in your 401(k)’s Summary Plan Description in many cases allow you as an employee to transfer part or all of your 401(k) funds to an IRA wherever you choose, while still employed by the company. The In-Service Distribution feature does not generally put a halt to your 401(k) or future contributions. Since many 401(k) plans offer limited choices of investment, and almost no flexibility outside of company stock or mutual funds, this can be an effective way to diversify investments to different areas during your working years.


Life Insurance


Of all the options designed to pass tax-free funds to your loved ones, life insurance may well be the most simple and powerful leveraging tool available. Many life insurance policies can also offer benefits beyond a payment upon death. A properly structured and correctly funded and managed policy can supplement retirement income, and provide access to tax-free lump sums when needed.


NUA (Net Unrealized Appreciation)


This often missed provision of the tax code can provide significant tax savings if you own highly appreciated company stock in your 401(k) Plan. Rather than rolling the stock over to an IRA upon retirement, thus eventually paying ordinary income tax on the entire  value of the stock, the shares can instead be transferred to a taxable account. The result – you’ll pay ordinary income tax on the cost basis, or the amount you paid for the shares. But upon sale of the shares, you will pay long- term capital gains rates. This rate applies even if you sell the shares immediately.


IRD (Income in Respect of a Decedent)


If you have inherited money, and paid both Income Tax and Estate Tax on your inheritance, chances are you qualify for this little known and almost never utilized tax break. Simply put, the IRS doesn’t think it’s fair that you pay both Estate Tax and Income Tax on the same inherited asset. The IRD never expires and you can go back up to 3 years and amend your tax returns to take advantage of it.


Windfall Income Amounts


The tax code offers very few avenues to mitigate the taxation on income or gains already realized. Sale of real estate or a business can create a sizable tax event, as can a large bonus. ROTH conversions can also fall into this category. However, another almost unknown area of the tax code – the ability to write off intangible drilling costs – can sometimes provide a partial solution. A direct investment into certain domestic energy development programs can provide a sizable tax break.

Ever wonder why they call it Form 1040? Because for every $50 you earn, you get $10 and they get $40.

protect your estate from federal taxes