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Financial Planning > Tax Planning

Making the Most of Tax Season

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Tax time may generate high anxiety for millions of Americans rushing to get their returns filed on time. But the season is an opportune time for you to help clients kick-start–or kick into high gear–their retirement, business and estate plans. The weeks preceding April 15th are also a great time to connect with prospects.

Many advisors are using the weeks leading up to the April 15th deadline for filing federal and state income tax returns to remind clients to maximize contributions to their 401(k)s, IRAs and Roth IRAs. The pitch should especially appeal to boomers who are eligible to receive an income tax refund this year and would be amenable to redirecting the money into these plans.

A retirement savings vehicle that came into force in recent years, the Roth 401(k), mirrors the contribution limits permitted under 401(k) plans ($16,500, plus $5,500 in catch-up contributions for employees age 50 or over). But unlike Roth IRAs, eligibility is not restricted by income threshold. And, as with the 401(k), employer-matching contributions are pre-tax.

Other planning opportunities can be identified by examining the client’s income tax return, specifically the taxable investments that cause clients the most pain come April 15. Among them: mutual funds, certificates of deposit, money market funds and bonds. By shifting funds from these taxable investments to tax-deferred vehicles, an advisor can reduce the client’s tax liability and boost retirement savings.

Proper tax planning, conversely, can free up dollars to purchase additional life insurance needed for the death benefit or for securing tax-free income in retirement. One option is a maximum-funded variable universal life (VUL) insurance policy.

Used by high net worth clients who could not fund a Roth because of the IRS cap on income, the technique entails contributing premiums up to the allowable limit under the Internal Revenue Code (i.e., the point at which the policy would convert to a modified endowment contract or MEC). Typically funded over 5-15 years, the VUL policy’s cash value grows tax-deferred. At retirement, the cost basis (premium contributions) can be withdrawn tax-free.

Many life insurance sales over the next couple of years will be used for estate and wealth transfer planning–a particular focus of high net worth clients in the current tax season. That’s because of the increases in the lifetime estate and gift tax exemptions enacted in December as part of the two-year extension of the Bush-era tax cuts.

The 2010 Tax Relief Act sets the individual lifetime estate and gift tax exemptions at $5 million per person and $10 million per couple. And the law establishes a top tax rate of 35% for 2011 and 2012 for both. For planners looking to help clients make substantial gifts over the next 24 months, the new exemption level–up from just $1 million in 2010–could be a boon for one’s advisory practice.

Although one’s CPA partners may devote themselves to income tax return preparation this time of year, their insights into cash flow can help point up, for example, the tax savings that business clients can enjoy by leveraging permanent life insurance to fund a traditional defined benefit or pension plan. Tax-deductible contributions used to pay the premiums can exceed the IRS limit on defined contribution plans. But experts caution that insurance is only suitable inside qualified retirement plans for businesses that can count a steady revenue stream.

How else can clients minimize their annual income tax bite while maximize savings for retirement? One option is to use a policy’s cash value to cover the tax bill due on a conversion from a traditional individual retirement account to a Roth IRA, thereby securing tax-free income at retirement. (Whereas a conventional IRA uses pre-tax dollars to build tax-deferred savings, the Roth IRA uses after-dollars and provides tax-free income on account earnings.) In 2010, taxpayers with modified adjusted gross incomes of more than $100,000 were able to convert to a Roth and spread the income taxes due on the transaction over two years: 2011 and 2012.)

But despite the much-touted benefits of converting, many taxpayers evidently didn’t like the concept. Or so it would seem, if the experience of Norman Jones Enlow Vice President Andy Cohen, a CPA I interviewed, is representative of the broader advisor community. Only about 1 in 10 of his clients elected to do a conversion last year; the others gave a thumbs down because of the potentially significant tax hit.

Alas, this is one Congressional idea for boosting retirement savings that seems to have fallen on deaf ears.


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