Strategies for Maximizing AfterTax Wealth Creation

1
Strategies for Maximizing After-Tax Wealth
Creation
NAPFA National 2007 May 4,
2007 Cheryl R. Holland, CFP
2
Tax-Deferred Savings

• Non-deductible IRAs and Roth IRAs
• Roth 401(k)s/403(b)s
• Children
• Partnerships/LLC/Sole Proprietorships
• Subchapter S/C Corporation
• Roth Conversions
• 2010
• Annual opportunities
• Funding IRAs at the first of the year

3
Tax Deferred Savings
Non-Deductible IRAs
Assumptions 9 return, 18 capital gains rate,
40.26 ordinary income tax rate
4
Tax Deferred Savings

• Funding IRAs and 401(k)s at the first of the year

4000 invested annually at 7 growth rate
5
Tax-Deferred Savings

• Funding 529 Future plans
• State income tax deduction
• Harvesting losses
• Health Savings Accounts
• Tax Relief and Health Care Act 2007
• 1035 Exchange
• Life insurance to an annuity
• Annuity to annuity and withdraw

6
Capturing efficiencies in delivering tax planning
advice Knowledge Management

• Automate processes
• Income tax letters
• Requesting returns
• Reviewing returns
• Charitable gift of appreciated securities
• Leverage technology
• Paperless exchange of returns
• OCR returns
• Extract key data points to CRM
• Create checklists
• Income Tax Return Review
• Income Tax Planning meeting

7
Sample Income Tax Letter

• February 1, 2007
• Mr. and Mrs. John Client
• 1000 Devine Street
• Irmo, SC 29063-9238
• Dear John and Jane
• The purpose of this letter is to assist you with
  gathering information for the preparation of your
  2006 income tax returns.
• 1099s
• The purpose of this letter is to assist you with
  gathering information for the preparation of your
  2006 income tax returns. According to our
  records, you will receive 1099s from Charles
  Schwab and Company, Inc with a projected mailing
  date of January 31st. If you do not have this
  information in hand shortly after this mailing
  date, please contact us. We will assist you in
  locating any missing forms.
• 1099-R
• You may receive a 1099-R related to the rollover
  of the 401(k) account. We are enclosing
  documentation to provide to your CPA reflecting
  the deposit of this rollover amount in your IRA
  Rollover account.
• SURRENDER OF LIFE INSURANCE POLICY
• Jane surrendered a life insurance policy with New
  York Life in 2006. The taxable gain on this
  policy should be on the 1099 from New York Life.
  If not, we can assist you in documenting this
  information.
• INDIVIDUAL RETIREMENT ACCOUNT CONTRIBUTIONS
• You each made a 4,000 non-deductible
  contribution to an IRA for the 2006 tax year.
  Please be aware that Form 8606 needs to be filed
  for these nondeductible contributions.
• John made a 4,000 contribution to a Roth IRA for
  the 2006 tax year.
• Jane made a 4,000 contribution to a Roth IRA for
  the 2006 tax year. As you are aware there are
  income limitations on the ability to fund a Roth
  IRA. If your adjusted gross income is too high,
  you will begin to lose the ability to fund this
  Roth IRA. If this occurs, let us know so we may
  take corrective action and reclassify this
  contribution.
• CHARITABLE GIFT OF APPRECIATED SECURITIES
• You made a gift of 150 shares of Pfizer for which
  we do not have the cost basis to Central Carolina
  Community Foundation. The value of the gift for
  income tax purposes will be on the statement
  provided by the charitable organization. Please
  provide this information to Kris when completing
  his tax organizer.

8
Sample Tax Letter Page 2

• MEDICAL EXPENSES
• Please be aware that the amounts you pay for your
  long-term care insurance are deductible as a
  medical expense on your Schedule A within certain
  constraints. The premiums paid for the year
  should be provided to your CPA.
• TRUST DISTRIBUTIONS
• Because you are the beneficiary of a Generation
  Skipping/Credit Shelter/. Trust, we have
  enclosed a distributions report for tax-year and
  a Portfolio Statement as of the end of the
  tax-year. If we have omitted any items that may
  be needed for preparation of this return, please
  have your CPA call me and we will be happy to
  provide the needed data.
• REALIZED GAINS/LOSSES
• We have enclosed a printout of your taxable sales
  for the year that provides cost basis and
  acquisition information.
• You will note there are a number of investments
  with an acquisition date of January 1, 1985. We
  do have the cost basis for these purchases but
  not exact acquisition dates for all blocks.
  Thus, January 1, 1985, is just a placeholder and
  is accurate for income tax reporting purposes.
• GIFT TAX RETURN
• During the 2006 tax year you made annual
  exclusion gifts to family members. We have
  provided this information to David Sojourner so
  that he may determine whether to file a gift tax
  return.
• SOUTH CAROLINA 529 PLAN
• During the year, you contributed 5,000 to the
  South Carolina 529 Plan. This contribution will
  reduce your taxable income on the South Carolina
  return and therefore your South Carolina tax
  liability. You should have a statement from the
  Future Scholar program reflecting your
  contributions for 2006 which you will need to
  include in your tax preparation package for your
  CPA.
• MARGIN INTEREST
• We are enclosing a report documenting the margin
  interest paid on your taxable accounts in 2006.

9
Sample Tax Letter Page 3

• MONEY MARKET INTERESTPORTION ATTRIBUTABLE TO
  U.S. SECURITIES OR SOUTH CAROLINA MUNICIPAL BONDS
• The money market managers will not be able to
  provide this information until late February.
  Once we have received the information, we will
  post it on the Abacus Planning Group website,
  www.abacusplanninggroup.com. If you will
  navigate to Strategic Partners and select
  Certified Public Accountants, you will be able to
  retrieve this information for all Charles Schwab
  and Company and Vanguard Group money markets and
  bond funds.
• REQUEST FOR FEDERAL AND STATE RETURN
• We hope this information is helpful. Please let
  us know if we can provide you or any additional
  information in preparing your income taxes. When
  your income taxes are completed, please make sure
  we receive a copy for our files.
• Sincerely yours,
• Cheryl R. Holland
• cc CPA

10
Managing the Tax Drag on Portfolios

• Mutual fund selection issues
• Exchange Traded Funds
• Asset location decisions
• Marginal Tax Bracket and Investment Decisions
• Money Market Fund Selection
• Tax Loss Harvesting
• Calculating and reviewing the tax drag on a
  portfolio as a benchmark

11
Managing the Tax Drag on Portfolios

• Mutual Fund Selection Issues

12
Managing the Tax Drag on Portfolios

• Asset Allocation Decisions

Ordinary tax rate 30 Capital gains rate 15
Stocks pre-tax return 8 Bonds pre-tax return
5 Number of years 30 Amount in IRA 500,000
Amount in taxable 500,000
Source Gobind Daryanani, Ph.D., CFP, and Chris
Cordaro, CFP
13
Managing the Tax Drag on Portfolios

• Asset Allocation Decisions

Source Gobind Daryanani, Ph.D., CFP, and Chris
Cordaro, CFP
14
Managing the Tax Drag on Portfolios
Mutual Fund Tax Efficiency

15
Managing the Tax Drag on Portfolios

• Asset Location Decisions

Source Gobind Daryanani, Ph.D., CFP, and Chris
Cordaro, CFP
16
Managing the Tax Drag on Portfolios
Marginal Tax Bracket and Investment Decisions
17
Managing the Tax Drag on Portfolios

• Money Market Fund Selection

18
Money Market Rates

• 4/3/2007 4/10/2007
• Schwab Value Advantage (SWVXX) 4.92
  4.92
• Schwab Advisor Cash Reserves (SWQXX)
  4.71 4.70
• Schwab Advisor Cash Reserves Premier (SWZXX)
  4.78 4.77
• Schwab U.S. Treasury (SWUXX) 4.48
  4.49
• SC tax equivalent yield (assumes 7 SC income
  tax) 4.82 4.83

19
Managing the Tax Drag on Portfolios

• Calculating and Reviewing tax drag as a benchmark

((Taxable interest plus non-qualifying dividends
plus short term capital gains x MTB) (Ordinary
qualifying dividends net long term capital
gains/loss x 18)) 12/31 balance portfolio
tax drag.
20
Nickels and Dimes

• Income with Respect to the Decedent for IRAs and
  annuities
• Capitalizing investment advisor fees
• UBTI for IRAs and CRUTs
• Deductibility of hedge fund fees
• Investment Interest deduction
• Charitable gift of appreciated assets or from IRA
• Net Unrealized Appreciation

21
Nickels and Dimes

• Capitalizing Investment Advisor Fees

'_at__at_ - No allocation of fees to tax-deferred
assets or real estate assets which pay a separate
fee so no reason to input gross proceeds for
these accounts. (1) To be input as a separate
line item on Schedule D as cost basis with zero
sales proceeds. It may also be added with other
sales.
22
Concentrated Positions

• Goal
• Diversifying a portfolio
• Providing a temporary hedge against a price
  decline
• Monetizing the position to provide liquidity for
  other needs
• Separate Account Workout, e.g. Parametric
• Charitable Remainder Unitrusts/Foundations
• Exchange Funds
• Equity Collars and Protective Puts
• Gift to charity
• Limit Orders

23
Concentrated Positions
Source Schwab Institutional
24
Prudent Investor Act

• (3) A trustee shall consider in investing and
  managing trust assets those circumstances of the
  following as are relevant to the trust or its
  beneficiaries
• (a) general economic conditions
• (b) the possible effect of inflation or
  deflation
• (c) the expected tax consequences of investment
  decisions or strategies
• (d) the role that each investment or course of
  action plays within the overall trust portfolio,
  including financial assets, interests in closely
  held enterprises, tangible and intangible
  personal property, and real property
• (e) the expected total return from income and the
  appreciation of capital
• (f) other resources of the beneficiaries
• (g) needs for liquidity, regularity of income,
  and preservation or appreciation of capital and
• (h) an asset's special relationship or special
  value to the purposes of the trust or to one or
  more of the beneficiaries.

25
Dont let the tax tail wag the dog
26
Bibliography

• FPA Journal Asset Location A Generic
  Framework for Maximizing After-Tax Wealth.
  Daryanani, Gobind, Ph.D., and Chris Cordaro.
  www.fpanet.org.
• Morningstar, Inc. Morningstar Principia
  Advanced Analytics. www.morningstar.com
• Schwab Institutional. Market Knowledge Tools -
  Investment Strategies to Reduce the Risk of
  Concentrated Positions.
• www.savingforcollege.com. 529 website.
• Investing with a Tax-Efficient Eye. Robert
  Gordon. CFA Institute Conference Proceedings.
  www.cfapubs.org.
• Ed Slotts IRA Advisor. 1-800-663-1340.

27
Bibliography

• www.foundationsource.com
• Gardner, Randy. Recent Developments Help Avoid
  the
• Double Tax on IRD Property. Journal of
  Financial
• Planning. February 2007. www.fpanet.org.
• Reiner, Eric L. A Sly Deduction. Wealth
  Manager. March 2007. www.wealthmanagermag.com
• Slott, Ed. NUA No-Nos. Financial Planning.
  July 2006.
• www.Financial-Planning.com
• Strobel, Caroline and Paul Steer. Proper
  Planning can Minimize the Impact in Respect of
  a Decedent. The Tax Advisor,Vol. 26,
• No. 5, May 1995, pp.297-304
• Swift, Marie. A Round of Transitions. Wealth
  Manager.
• February 2007. www.wealthmanager.com