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Financial Planning > Tax Planning

Five Tax Tips for a Recession

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Sure, it’s summer and the living is easy, but it’s not too early to begin thinking about the 2009 tax strategies that will enable your clients to minimize what they hand over to Uncle Sam.

In addition to evergreen pointers like maximizing contributions to qualified retirement plans and harvesting portfolio losses, the down market and new tax credits have created a silver lining in the current financial cloud that’s worth exploring.

I spoke with Brett Ellen, CFP, president and CEO of American Financial Network, Calabasas, Calif., to get his thoughts. Here are five timely tax tips that can deliver extraordinary long-term benefits.

1. Convert a traditional IRA to a Roth IRA.

If you and your clients have discussed the benefits of converting a traditional IRA to a Roth IRA where qualified withdrawals are tax free, many likely balked at the cash outlay to pay conversion taxes.

Ellen points out, however, that as many investment accounts have declined in value over the past year, clients who convert this year will owe less tax than they might have in the past. The extra bonus is that their new Roth will capture gains from the market’s eventual rebound on a tax-free basis.

“Of course we expect the market to recover – just look what it’s done so far this year, all with no money coming off the sidelines,” he says. “Clients understand the benefit of buying investments cheap and having them appreciate as the market recovers, but when they convert to a Roth, the bonus is they will withdraw those appreciated assets tax free at a time in the future when it’s likely the tax rate will be higher than it is today.

“Let’s say a client moves $400,000 to a Roth and it’s worth $1 million 10 years from now. The $70,000 paid in taxes to convert could create an account that could support a tax free annual withdrawal of $70,000 to $80,000 for 20 years,” Ellen says.

While those tax savings would far exceed the initial tax paid to convert, Ellen notes that for some clients a combination of investment strategies and planning techniques can enable them to avoid paying taxes on the Roth conversion.

For example, Ellen is working with 61 year-old client with a $700,000 traditional IRA and a house worth $300,000. She owes only $50,000 on her home and although the monthly mortgage payments are low, she is frustrated by high taxes.

Ellen recommended taking out a $120,000 loan for 30 years to increase mortgage interest deductions from $2,000 to $7,000. Additionally, he’s using a combination investment tax credits and passive losses from her rental property to move approximately $40,000 a year form her traditional IRA to a Roth with zero tax, with the goal of converting $400,000 over a ten-year period.

This year, clients can convert their traditional IRA to a Roth IRA if their modified adjusted gross income (MAGI) is under $100,000. Note, however, that the income cap is scheduled to disappear in 2010, courtesy of the Tax Increase Prevention and Reconciliation Act of 2006. After 2010, there are no income limits for a conversion.

2. Take full advantage of the $8,000 credit for first-time homebuyers.

If your client is in the market for their first home, falling real estate prices and low interest rates are obviously good news. Additionally, the American Recovery and Reinvestment Act of 2009 authorizes a tax credit equal to 10 percent of the home’s purchase price up to a maximum of $8,000 for qualified first-time home buyers purchasing a principal residence on or after January 1, 2009 and before December 1, 2009.

While that should excite your clients, Ellen advises investing the $8,000 saved into a Roth. “The best time to get into a Roth is when you are in a low tax bracket, but younger clients don’t generally have a traditional IRA they can convert,” Ellen explains. “I suggest first-time homebuyers who get the credit and have a 401(k) plan that offers a Roth option, invest in the Roth instead of making pre-tax 401(k) contributions. Over 30 years, that $8,000 can grow into a healthy tax-free retirement account.”

Note that the law defines “first-time home buyer” as a buyer who has not owned a principal residence during the three-year period prior to the purchase. For married taxpayers, the law tests the homeownership history of both the home buyer and his/her spouse.

The tax credit is subject to income limits: income limit for single taxpayers is $75,000; the limit is $150,000 for married taxpayers filing a joint return. The tax credit amount is reduced for buyers with a modified adjusted gross income (MAGI) of more than $75,000 for single taxpayers and $150,000 for married taxpayers filing a joint return.

3. Defer compensation.

While many argue if tax rates go up, deferring salary into the future doesn’t make sense, Ellen thinks differently. “Qualified retirement plans like the 401(k) limit what you can invest. However, deferring compensation extends that limit, enabling clients to buy more shares now when prices are low,” he explains.

“Salary deferral could also bring a client’s income under $100,000, qualifying him to convert to a Roth this year. What’s more, in addition to a tax benefit this year and the promise of tax-deferred growth, if the deferred compensation is invested for more than ten years, when withdrawals begin, you pay taxes in the state where you currently reside, not where you earned the money. That’s a bonus for those retiring to states where there is no state income tax.”

In short, Ellen views salary deferral not as a supplemental retirement plan, but as a salary extension plan. He notes, “Do it right and you could create a ten-year income stream. That’s especially attractive in down market because rather than being forced to withdraw assets when your retirement accounts are under water, if you have another bucket to draw income from you can let retirement funds recover.”

4. Start a defined benefit plan.

For consultants suffering through a down year income-wise, a plus is that they may be able to contribute more to their defined benefit plan. If they don’t have a plan, this is a great year to start one. Ellen’s firm has done hundreds already

“The older you are and the less you have in retirement assets, the more you can put into your defined benefit plan,” he explains. “Everyone is concerned when the market goes down and retirement accounts plummet, but in the pension world when assets go down, you can make greater contributions. Today’s low interest rates and lower account values are two characteristics that allow for higher pension contributions.”

5. Consider interfamily sales of businesses or real estate.

Down values for non-tradable assets are creating estate planning opportunities, says Ellen. “If you have a business worth $10 million and revenue’s down 50 percent, consider selling 25 percent to a child via an interfamily loan where they have a promise to pay,” he explains. “Ten years later, the 25 percent you sold could be back to being worth $2.5 million – an asset that’s now outside of your estate.”

Obviously, some of these strategies require sophisticated estate planning and specific tax planning expertise. To that end, Ellen looks forward to the September 14 meeting of his Collaborative Services Platform group (see

“Nobody can be an expert in all areas, so for five years we’ve been bringing great minds and resources together,” he notes. Particularly in today’s fast-moving, challenging market, Ellen’s “we’re stronger together” philosophy makes a lot of sense.

Marie Swift, president and CEO of Impact Communications, has worked as consultant in the financial services industry for more than 20 years. Read her blog at or download free resources at


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