Why? You're probably giving up part of your pay package, and worse, any tax deferral you thought you were getting has been significantly devalued. That's because future withdrawals from a tax-deferred account will be taxed at the account owner's income tax rate, rather than the long-term capital gains rate of 15%. They may be far better off contributing to a Roth IRA if they meet the income limits, because withdrawals will be tax-free. That contrasts sharply with 401(k) accounts, particularly those with unmatched contributions, because withdrawals will be taxed as ordinary income.
Even though no provisions of the bill carry the "retirement" moniker, it offers some interesting provisions for retirement tax planning. For instance, the new tax law presents the opportunity for retired clients to consider taking IRA withdrawals between the ages of 59 1/2 to 70 1/2, when they may be able to take the withdrawals at the 10%-to-15% level if their income level is low enough. After age 70 1/2, they'll be forced to take the distributions at higher tax brackets. The move also allows investors whose IRA money far exceeds their non-IRA money to balance things out.
If the law allows clients to reduce income, it's worthwhile to reconsider whether investors are now eligible for a deductible, traditional IRA. A non-working spouse of a covered employee might also qualify for an IRA deduction now. Just as interesting, say advisors, is the prospect that those who can reduce adjusted gross income rates-small-business owners come to mind here-may qualify for a Roth IRA contribution or may even be able to do a Roth IRA conversion tax-free if they are able to load up on depreciation deductions that produce negative income for the year. Here's how that would work: Say a client has adjusted gross income of $150,000 in 2003, but because of $200,000 in paper losses in their business is able to report negative income of $50,000. This gives him or her the opportunity to convert $50,000 in IRA money to a Roth IRA tax-free.
Savvy Planning For Business Clients
One of the greatest tax windfalls in the new act, as we alluded to above, goes to business owners. "We're telling clients with businesses that if they need equipment, now is the time to buy it," says Ken Eaton, a planner with Stepp & Rothwell Inc., an advisory firm in Overland Park, Kan.
That's because the tax law changed IRS code Section 179 to allow business owners much expanded first-year deductions for business equipment. The maximum write-off for 2003 is now $100,000, up from the $25,000 allowance in prior law.
It's a quirky change, to be sure, but one that can pay for advisors and their clients who have a clear read of the law and its potential benefits. For instance, while the new expensing election won't help much if you buy a business car, it will help if you buy a sports utility vehicle or truck that weighs more than 6,000 pounds. If a client buys an SUV for $40,000 and uses it 90% of the time for business, they may be able to deduct $36,000, up from the prior maximum deduction of $25,000. With the new $100,000 cap for first-year expensing, the client could still deduct another $64,000 in business expenses.
For sole proprietors, S corporations, partnerships and limited liability companies, this overall business deduction can be used to reduce adjusted gross income. Eaton says this is where, for many who are accustomed to having far higher AGIs, the potential for creating or converting Roth IRAs comes in.
Add Value And Underscore It
Part of adding value may mean advising clients not to play into vague notions or hybrid, short-term solutions, since changing tax and estate plans can be pretty pricey. A case in point: The new tax act essentially eliminates some planning opportunities that were introduced just two years ago. And it's taxpayers, not surprisingly, who are left holding the bag, says Phil Cook, owner of the advisory firm of Cook and Associates, Torrance, Calif.
To illustrate the risks of tax planning when tax laws change every year or two, consider the strategy from the 2001 tax act known as the "deemed sale election," Cook says. Under this election, some 2001 taxpayers got to "pretend" they sold assets they had bought before 2001 and paid the then-current capital gains tax rate on their phantom sale. The strategy allowed them to pay a lower tax rate on any future capital gains as long as they waited at least five years to actually sell the property. "The new tax act has wiped out the advantage of making that tax move, which was an irrevocable election," says Cook.
Particularly when it comes to tax planning, some clients might need you to save them from themselves.