Investment Strategies

The 1031 Exchange, also known as the like-kind exchange, is a powerful tool in the arsenal of savvy real estate investors. In its essence, this provision, under the IRS code, allows investors to defer paying capital gains taxes on an investment property when it's sold, as long as another "like-kind property" is purchased with the profit gained by the sale of the first property.

What is a 1031 Exchange?

The term "1031 Exchange" is defined under section 1031 of the IRS code. Essentially, it provides an exception and allows you to postpone paying tax on the gain if you reinvest the proceeds in similar property as part of a qualifying like-kind exchange. Gain deferred in a like-kind exchange under section 1031 is essentially tax-free growth.

The concept behind the 1031 Exchange is that since you're merely exchanging one property for another, you aren't really gaining anything new or making a profit, so you shouldn't need to pay tax on a transaction. Of course, there are specific rules and processes to follow to make sure this transaction falls under the 1031 Exchange rules.

Which Property Transactions are Allowed?

The IRS stipulates that the properties involved in the transaction must be "like-kind" to qualify for a 1031 Exchange. This is a broad term which means that the property being sold and the property being acquired must both be similar in scope and use. The good news for real estate investors is that most properties will be like-kind to each other as long as they are held for productive use in a trade, business, or for investment. This includes residential rental properties, commercial properties, industrial properties, and land. However, properties used primarily for personal use, like a primary residence or a second home, do not qualify.

Navigating the 1031 Exchange

To navigate a successful 1031 Exchange, several important rules and requirements need to be adhered to:

The Same Taxpayer Rule - The tax return, and the name on the title of the property being sold, must be the same as the tax return and the title holder that buys the new property.
The 45-Day Identification Window - From the day the sold property's sale closes, the seller has 45 days to identify potential replacement properties. The properties must be clearly described in a written document and signed by the taxpayer, then delivered to the seller.
The 180-Day Purchase Rule - The new property must be purchased within 180 days of the sale of the old property or by the due date of the individual's tax return for the taxable year in which the relinquished property was transferred, whichever is earlier.
The Exchange Must Be Of Equal Or Greater Value - To completely avoid paying any taxes at the time of the exchange, the new property must be of equal or greater value. Also, all the proceeds from the sale must be used to acquire the new property.
Qualified Intermediary Requirement - A qualified intermediary (QI), also known as a 1031 exchange accommodator, must be used to facilitate a 1031 exchange. The QI holds the sale proceeds from the old property and then uses them to buy the new property for the investor.

Savvy Real Estate Investing with 1031 Exchange

The 1031 Exchange is a smart tool for real estate investors looking to grow their portfolios. It promotes continuity in investment and business activity by allowing investors to reinvest the proceeds from a sale into new investment properties. They can continue to make their money work for them, without losing momentum due to capital gains taxes.
One strategy real estate investors may use is to trade up their properties using the 1031 Exchange. This means continuously deferring their capital gains taxes while moving their investments from smaller, potentially less profitable properties to larger, more lucrative ones. Over time, this method could lead to a substantial portfolio of high-yielding properties, all stemming from the profits of that first sale, and made more efficient by deferring capital gains tax.

Another clever tactic is to leverage the 1031 Exchange for diversification. For instance, if an investor holds multiple properties in one city or state and identifies a promising opportunity in a different location, the investor could sell off a portion of their current holdings and use the 1031 Exchange to acquire the new properties, thereby spreading risk across geographical locations without incurring immediate capital gains tax.

Investors nearing retirement can utilize a 1031 Exchange to shift their investment strategy. They could exchange high-maintenance properties, like multi-family or commercial properties, for lower-maintenance ones, such as triple-net-lease properties, without the tax obligation. This allows a transition into a more passive investment style suitable for retirement, again, without the capital gains tax burden.

The Importance of Professional Advice

While the 1031 Exchange presents significant tax advantages and opportunities for growth, the rules governing its implementation are intricate and require careful navigation. Mistakes in executing a 1031 Exchange can lead to the disqualification of the entire transaction, turning what was meant to be a tax-deferred exchange into a taxable event.
This is why it's crucial to consult with your CPA, who is knowledgeable about 1031 Exchanges. They can provide guidance tailored to your specific situation, helping ensure the transaction goes smoothly, that you adhere to all the guidelines, and that you can reap the full benefits of this powerful investment strategy.

The 1031 Exchange is a powerful instrument in real estate investment, offering opportunities for portfolio growth, diversification, and strategic repositioning, all while deferring capital gains tax. Whether you're a seasoned investor or a newcomer to real estate, understanding and applying the 1031 Exchange could improve your financial gains. With professional guidance from your CPA, you can leverage the 1031 Exchange to achieve your real estate investment objectives while navigating complex tax implications effectively.

In today's world, you need to work smarter, not necessarily harder. To accomplish this, you should take a closer look at generating passive income. Rather than always struggling to earn a few dollars here and there, it pays to find ways that will have your money working for you, rather than the other way around. If you're ready to be anything but passive about earning more income, here are nine ways to generate passive income.

1. Invest in Rental Properties

When you are having a discussion with your CPA about ways to earn passive income, don't be shocked if your CPA encourages you to invest in real estate. One of the most reliable methods for earning passive income, becoming a real estate investor can have you making more money than you ever imagined. However, before diving into this opportunity, think about all the things that go with being a landlord, such as repairs and maintenance of your properties. If you decide to hire a property manager for your properties, this too could eat into your passive income profits.

2. Install Vending Machines

Whenever you've been in an office building, arena, or elsewhere, you know that people just can't resist buying something from a vending machine. If you don't mind spending a few thousand dollars to get started, you too can begin building your vending machine empire. From soda and candy to healthy snacks and everything in between, vending machine businesses require only a few hours each week to service and restock the machines. Best of all, you can outsource these tasks, meaning you'll have even more free time to spend that extra money you're making with very little effort.

3. Advertise On Your Car

Since you are probably already spending plenty of your time driving around in towns and cities, why not get paid for doing so? If you don't mind turning your vehicle into a mobile advertisement for businesses, you can make a sizable passive income for the time you spend behind the wheel. While some businesses may want to do a full vehicle wrap, others may just want to place a small magnetic sign on your door. Whatever the case may be, once you make your vehicle available for business advertising, you'll get more offers than you expected.

4. Buy Dividend Stocks

If you are looking to invest your money in an effort to create passive income, your CPA may suggest you take a close look at dividend stocks. Though you will need several thousand dollars at a minimum to get this off the ground, dividend stocks are proven moneymakers year in and year out. Though it does come with risks, such as companies hitting lean stretches and being unable to pay out a dividend or only pay out a small one, chances are that by working with your CPA and a stockbroker you can trust, regular profits will come your way month after month.

5. Become a Silent Partner

You can make plenty of passive income by becoming a silent partner in a business. Since businesses of all types are always looking for investors who can help them become even more successful, you may be surprised at just how many small businesses may want to talk to you about this in greater detail. If you decide to pursue this, meet with your CPA before you sign any documents or provide a business with any money, since you will want to make sure the opportunity is legitimate and that any contract you may sign will be valid and reasonable.

6. Take Advantage of Matching Contributions

If you have a 401(k) retirement account through your employer, take advantage of the matching contributions made by your employer to your account. When you do, this is arguably the easiest way you can earn passive income. Since you will already have your account set up so that money you earn automatically goes into your account, maximizing your contribution will mean your employer will put more and more money into your account. What could be easier than that?

7. Host on Airbnb

Should you be someone who travels quite a bit and is leaving behind an empty house, you can earn passive income on your home by renting it out on Airbnb. While you will need to spend some of your time getting the place ready for guests and cleaning it up after they leave, you can quickly earn thousands of dollars by letting others enjoy your beautiful home for a few days.

8. Become a Song Investor

Whether it's in a TV show, movie on the big screen, or in those always-popular commercials, you've noticed songs are always being used in different ways. Believe it or not, you can actually become a song investor and earn money each time a song you've invested in is used on television or the silver screen. If this sounds intriguing, remember that this does not just pertain to current songs. In fact, the song "Daydream Believer" by The Monkees rakes in an average of $10,000 each year when it's used in various ways.

9. Write an eBook

Should you have knowledge you want to share with others or perhaps have an inner novelist in you that is eager to write the next best-selling book, you can generate passive income by writing and selling an ebook. Once you get the book written and ready for publication, you can take advantage of Amazon's Kindle Direct Publishing program and do it quickly, easily, and for free. Once your book gets listed on Amazon and other online bookselling sites, the profits could start to roll in 24/7.

Now that you have so many options in front of you as to how you can generate passive income, pick out some and then get some sound financial advice from your CPA. Whether you want to invest in real estate, become a silent partner in a new or existing business, or perhaps let The Monkees and other artists increase your bank account, it won't be long until you are indeed working smarter rather than harder.

One of the major complications facing aging individuals is the passing down of wealth to the next generation without creating large tax implications.  The dynasty trust is a straightforward estate planning technique that can substantially reduce taxes.

The dynasty trust is a long-term trust, spanning the length of years after the death of the creator of the trust, used to pass wealth from generation to generation without incurring the transfer taxes that are usually associated with gift tax, estate tax and generation skipping tax.  Assets that are transferred into a dynasty trust are subject to tax when the transfer is made and only if the assets exceed the federal tax exemption limits.  If adequately funded and managed, a dynasty trust can ensure financial support for generations without taxation and without the uncertainty of what will be done with the assets.

Historically, wealthy heads of family would create trusts that utilized the distributions to the decedent beneficiaries for maintenance and would then distribute the principal to the grandchild upon death.  Once it was realized that this allowed estate taxes to essentially skip a generation, Congress enacted the generation skipping transfer tax.  Generation Skipping Trusts were first introduced in the late 1970s that went after direct gifts as well as transfers to trusts for the benefit of an unrelated person who are more than one generation younger than the donor.  With this came an exemption.  In 2018, the exemption is $11.18 million (single).  Since dynasty trusts are taxed only on the amount of transfer above the exemption allowed for a Generation Skipping Trust, wealthy families can pass along at least the exemption amount to their heirs tax-free.  Furthermore, the gains on the transferred assets are also exempt from gift and estate taxes.  Dynasty trusts are also irrevocable, ensuring that the trust stays out of the grantor’s estate at death.  The beneficiaries also do not retain control of the trust assets, and they are therefore not counted toward the beneficiaries’ taxable estates.

An additional benefit of dynasty trusts is that they can shield assets from liabilities that may arise for the beneficiaries.  Because the assets are not owned or controlled by the beneficiary, they cannot be included in marital estate for divorce process or child support, subject to creditor claims, or civil judgments.  Temporary trusts cannot provide this same level of protection.  As temporary trusts are predetermined at its creation, it can be terminated based on the age of the beneficiary, after a certain number of years, or a variety of other instances that may not suit the needs of the beneficiary.

When setting up a dynasty trust, it is important to also look at the state.  Many states do not allow for trusts to live on past the death of the grantor and have set up limitations also known as Rule Against Perpetuities.  Certain states, such as Alaska, Delaware, Nevada, New Hampshire, and South Dakota have done away with perpetuity rules.  An additional cause for concern during the creation of the trust is if the state has personal income tax.  If so, the distributions to the beneficiaries may create an income tax liability.  Any non-distributed income of the trust will generally be subject to income tax in the state of jurisdiction as well.  Choosing a state without income tax to establish the trust in can lend itself to additional tax benefits to future generations as well.

Dynasty trusts can also be set up to provide for charitable giving.  There are two ways in which a charity can benefit from a dynasty trust.  The first is simply to have the charity be a named beneficiary of the trust.  Be sure to structure the trust so that the charity only receives the trust assets not used by the decedent beneficiaries.  This puts family first and any remainder goes to the charity. Another option is to couple the dynasty trust with a charitable lead trust.  This allows for guaranteed charitable giving alongside the distributions to descendants.

One of the great benefit to a dynasty trust is the ability to dictate much of the requirements of the distributions.  The wording can dictate amounts due to charities, maintaining good credit by the beneficiaries, medical and education distributions, support and the like.  This allows for continuation of the values of the original grantor.  The verbiage of the trust ensures that the distributions are made and are generally for immediate use.  There are times that it may be desired for the trust to provide a loan to a beneficiary for additional capital, or to directly invest in an asset for the beneficiary.  While a beneficiary can serve as trustee, for the continued assuredness of the grantor’s vision, money lending, better asset protection due to distance from the assets, and prevention of establishing a new trustee upon death, an institutional trustee is generally preferred.  It is important to be sure that the trust contains language regarding the hiring and firing of a trustee, as well as having provisions regarding when, if ever, a beneficiary can become a trustee.

The benefits of a dynasty trust is that it allows you to preserve your wealth for future generations, continue to give charitably after death, provide asset protection, and save on taxes.  The limitations on flexibility during your own and future generations lifetimes can be a disadvantage over more temporary trusts.  There are many ways to fund and structure a dynasty trust to ensure continued support for the family.  As with all types of estate planning, deciding whether to incorporate a dynasty trust is a big decision.  Careful evaluation of your estate and your goals should be made with your financial advisors.

There is plenty of misunderstanding about the definition of cryptocurrency. Wikipedia’s well-researched entry on the topic defines “cryptocurrency” as follows (with their links included):

[Cryptocurrency is] a digital asset designed to work as a medium of exchange that uses cryptography to secure its transactions, to control the creation of additional units, and to verify the transfer of assets. Cryptocurrencies are a type of digital currencies, alternative currencies and virtual currencies. Cryptocurrencies use decentralized control as opposed to centralized electronic money and central banking systems. The decentralized control of each cryptocurrency works through a blockchain, which is a public transaction database, functioning as a distributed ledger. Bitcoin, created in 2009, was the first decentralized cryptocurrency. Since then, numerous other cryptocurrencies have been created.

Why create or use a cryptocurrency?

The answer is simple: freedom. (Freedom from centralized powers, to be exact.)

They’re used outside existing centralized banking and government structures, and this is why it’s attractive to users. They’re also mostly exchanged over the internet, which adds to the flexibility.

Coin Telegraph points out the intriguing characteristic of cryptocurrency:

While these alternative, decentralized modes of exchange are in the early stages of development, they have the unique potential to challenge existing systems of currency and payments. As of December 2017 total market capitalization of cryptocurrencies is bigger than 600 billion USD and record high daily volume is larger than 500 billion USD.As of January 2018, there were over 1384 and growing digital currencies in existence.

Many people buy cryptocurrency as they would an investment, with the hopes of profiting from its fluctuation in price. It’s also commonly used as a way to spend money as more and more businesses accept Bitcoin and others for payment.

Concerns About Cryptocurrencies and Legality Issues

Also noted by Coin Telegraph, but in a separate report, the world is still trying to wrap its head around the concept of Bitcoin and the security and legal implications of cryptocurrency. It’s also not surprising that governing agencies and central powers are worried and not particularly happy about a “rogue” financial community that they can’t control.

As Coin Telegraph observes: this also extends to exchanges and protection of people’s funds. US-based exchanges have to be regulated, but there are plenty of offshore platforms that don’t. (And some onshore platforms have blatantly broken the laws of the US.) The cryptocurrency history has been filled with instances of exchanges shutting down and running away with people’s funds.

The most famous of such cases is the closure of the notorious exchange Mt.Gox. At the beginning of 2014, formerly the most prominent Bitcoin exchange in existence filed for bankruptcy due to technological problems and the apparent theft or loss of 744,000 of its users Bitcoins. That number made up about six percent of 12.4 mln Bitcoins in circulation at the time.

Bitcoin’s ability to be used semi-anonymously is another cause for concern. Even though every single transaction is recorded in the Blockchain, it is very easy for users to stay almost completely anonymous, as those records only contain the public keys and the amount of funds transferred.

Most of these concerns were voiced after a dark web market Silk Road gained mainstream-media attention, as Bitcoins were the only form of payment accepted there. The market was since shut down by the FBI, but the authorities are still worried about Bitcoin’s appeal among the traders of illegal goods and services. Moreover, it is feared that Bitcoin’s semi-anonymity and decentralized nature can be exploited in money laundering and tax evasion schemes.

In 2013, Bitcoin was classified as a convertible decentralized virtual currency by the US Treasury Department’s Financial Crimes Enforcement Network (FinCEN). They have also issued a guidance, in which they stated that those who obtain units of virtual currency and use it to purchase goods are not considered money transmitters and are operating within the law.

So basically it comes down to this: buying well-natured goods and services with Bitcoins is completely legal. The cryptocurrency is accepted as a form of payment on several major and minor online marketplaces and service providers, including Overstock, Shopify and OKCupid. Moreover, there are shops and restaurants all over the US where you can pay with Bitcoins.

Investing

According to the same guidance, investing in Bitcoin is also within the legal territory.  Many regulated US-based exchanges have to comply with the Anti-Money Laundering and Know Your Customer policies. Because of that, those who wish to trade and invest in Bitcoin have to verify their ID and connect an existing bank account.

Although, the US Securities and Exchange Commission (SEC) has warned potential investors that both fraudsters and promoters of high-risk investment schemes may target Bitcoin users.

Of course, readers might feel a bit overwhelmed trying to process the concept of cryptocurrency and all that it implies. We recommend that interested parties seek out guidance from your attorney and financial advisor prior to becoming financially engaged, or invested, in cryptocurrencies.

So what happens when you inherit retirement plans? It all depends on the type of account. It also depends on whether the beneficiary is a spouse. Those variables will determine the rules that govern how the inheritance is taxed and what options are available. These rules can be confusing and it’s highly recommended that you seek out professional advice to make sure that your understanding is valid before making any decisions that would have significant financial impact.

The following summary, as structured by Schwab, highlights some of the significant differences in the rules between Spouse/Non-Spouse Traditional IRAs/Roth IRAs:

Traditional IRA / Spouse Inherits

If you inherit a Traditional, Rollover, SEP, or SIMPLE IRA from a spouse, you have several options, depending on whether your spouse was under or over age 70½. Most commonly, those who inherit an IRA from a spouse transfer the funds to their own IRA.

1. If your spouse was under 70½, your choices are:
   1. You transfer the assets into your own existing or new IRA.
   2. You transfer the assets into an Inherited IRA held in your name.
      1. Life Expectancy Method
      2. 5 Year Method
   3. All assets in the IRA are distributed to you.
2. If your spouse was over 70½, your choices are:
   1. You transfer the assets into your own existing or new IRA.
   2. You transfer the assets into an Inherited IRA held in your name.
      1. Life Expectancy Method - Only
   3. All assets in the IRA are distributed to you.

Traditional IRA / Non-Spouse Inherits

If you inherit a Traditional, Rollover, SEP, or SIMPLE IRA from a friend or family member, you have several options, depending on whether the account holder was under or over age 70½.

1. If your spouse was under 70½, your choices are:
   1. You transfer the assets into an Inherited IRA held in your name.
      1. Life Expectancy Method
      2. 5 Year Method
   2. All assets in the IRA are distributed to you.
2. If your spouse was over 70½, your choices are:
   1. You transfer the assets into an Inherited IRA held in your name.
      1. Life Expectancy Method – Only
   2. All assets in the IRA are distributed to you.

Roth IRA / Spouse Inherits

If you are inheriting a Roth IRA as a spouse.

1. You transfer the assets into your own existing or new Roth IRA.
2. You transfer the assets into an Inherited IRA held in your name.
   1. Life Expectancy Method
   2. 5 Year Method
3. All assets in the Roth IRA are distributed to you.

Roth IRA / Non-Spouse Inherits

If you are inheriting a Roth IRA from a friend or family member

1. You transfer the assets into an Inherited IRA held in your name.
   1. Life Expectancy Method
   2. 5 Year Method
2. All assets in the Roth IRA are distributed to you.

Images courtesy of Ivan @ Flickr

Tired of writing those rent checks that seem to get you little, if anything, for your money? It’s understandable, then, that you would consider tapping into your 401(k) funds to come up with the down payment to pay for the purchase of your first home. These sentiments are no doubt exacerbated if the resources you need for that dream house are just sitting there in your 401(k) account.

Like much of anything else in the world of personal finance there are pluses and minuses to accessing your 401(k) assets to help pay for that dream house. Watch out for one of the more significant cons whenever touching money from a 401(k): the potential for an early withdrawal penalty. The bottom-line question then is this: can you use 401(k) assets to purchase a home without an early withdrawal penalty and (or) income tax?

There are two methods of getting funds out of a 401(k) for the purchase of a home: (1) Loan--no income tax or penalty; or (2) hardship withdrawal--income tax and penalty will be owed.

Key features of a 401(k) plan loan are as follows, according to the 401kHelpCenter:

• It's convenient. There is no credit check or long credit application form.

• You pay a low interest rate set by the plan, usually one or two percentage points above the prime rate.

• Most plans allow you to borrow for any reason.

• You are paying the interest to yourself, not to the bank.

• The interest is tax-sheltered. You don't have to pay taxes on the interest until retirement, when you take money out of the plan.

• Funds obtains from a loan are not subject to income tax or the 10% early withdrawal penalty (unless the loan defaults).

As noted by the same author, it is probably not wise to take out a 401(k) plan loan when:

1. You are planning to leave your job within the next couple of years.

2. There is a chance you will lose your job due to a company restructuring.

3. You are nearing retirement.

4. You can obtain the funds from other sources.

5. You can't continue to make regular contributions to your plan.

6. You can't pay off the loan right away if you are laid off or change jobs.

7. You need the loan to meet everyday living expenses.

As noted in Home Guides:

1. 401(k) withdrawals under hardship exemptions, such as home buying, face 10 percent penalties on such withdrawals.

2. In addition, if you withdraw from your 401(k) you must pay income tax on it at tax time. All taxes on 401(k) withdrawals are due in the year the withdrawals occurred.

3. Lastly, withdrawing money from your 401(k) will cost you in terms of lost earnings on the money you withdrew from that 401(k).

The bottom-line is this, as noted by Home Guides: if you’re looking to use your 401 (k) to assist in a home purchase, do it through a loan. A 401(k) loan has certain advantages over a straight withdrawal. For one, the interest paid on a 401(k) loan goes back into the account, meaning even more money eventually ends up in it. 401(k) loan fees may apply, and if you default on it you'll owe standard penalties and taxes.

Image courtesy of Sherwood CC @ Flickr

A 529 College Savings Plan is a plan operated by a state or educational institution, with tax advantages and potentially other incentives to make it easier to save for college and other post-secondary training for a designated beneficiary, such as a child or grandchild.

529 College Savings Plans are investment vehicles designed to help families pay for future expenses associated with college or other qualified post-secondary training. Though contributions to a 529 plan are not deductible, these plans offer other tax advantages and are named after Section 529 of the Internal Revenue Code.

As noted by SEC.gov, 529 plans are also known as “qualified tuition plans.” States, state agencies, or educational institutions sponsor these plans, and all 50 states and the District of Columbia sponsor at least one type of 529 plan.

Some of the top benefits of 529 plans, as noted in SavingForCollege.com, are as follows:

1. 529 plans offer unsurpassed income tax breaks.

• Although contributions are not deductible, earnings in a 529 plan grow federal tax-free and will not be taxed when the money is taken out to pay for college.

• This has been a huge incentive for Americans to save for college. The tax treatment was made permanent with the Pension Protection Act of 2006.

1. You can generally claim state tax benefits each time you contribute to your plan, so it's a smart idea to continue keep making deposits until you've paid your last tuition bill.

2. You, the donor, stay in control of the account.

• With few exceptions, the named beneficiary has no legal rights to the funds so you can assure the money will be used for its intended purpose.

• A 529 account owner can withdraw funds at any time for any reason -- but keep in mind that the earnings portion of nonqualified withdrawals will incur income tax and an additional 10% penalty tax.

1. Low maintenance

• The ongoing investment management of the account is handled by an outside investment company hired as the program manager or by the state treasurer's office.

1. Simplified tax reporting

• Contributions to a 529 plan do not have to be reported on your federal tax return.

• You won't receive a Form 1099 to report taxable or nontaxable earnings until the year you make withdrawals.

• Deposits to a 529 plan up to $14,000 per individual per year ($28,000 for married couples filing jointly) will qualify for the annual gift tax exclusion.

1. Flexibility

• You can change your 529 plan investment options twice per calendar year.

• You can rollover your funds into another 529 plan one time in a 12-month period.

1. Everyone is eligible to take advantage of a 529 plan.

• Unlike Roth IRAs and Coverdell Education Savings Accounts, 529 plans have no income limits, age limits or annual contribution limits.

• There are lifetime contribution limits, which vary by plan, ranging from $235,000 - $400,000.

A Need for Greater Awareness about 529 Plans

In a recent May 2016 article from The Washington Post, the writer observed a need for greater awareness about 529 plans. In fact, as the Post notes, 72 percent of Americans do no know what a 529 plan is. And when people do know about it, there are misconceptions. One common misconception is the belief that a child can only go to schools in the state where the parent holds the 529 account. The truth is that any money invested in a 529 is available to use at any public or private school in the nation. In fact, the 529 can even be used in many schools around the world.

The Effect of 529 Plans on Financial Aid

As is the case with any source of funding that you use to pay for a student’s college education, you should always double-check with the financial aid office of your child’s institution. As noted in a recent May 2016 Forbes article, the 529 can have an effect on a student’s financial aid package. Generally speaking, on the FAFSA form (the form used by students to apply for financial aid at colleges), a 529 plan owned by the custodial parent(s) counts as an investment when the financial aid office assesses what resources a family has to pay for college. As an investment, the 529 plan may reduce need-based aid, but—and this is the good news—it cannot be more than 5.64% of the asset’s value, according to FAFSA regulations. In many cases, however, depending on the family’s income situation, the 529 plan has minimal or no impact on a student’s financial aid package.

In addition, even when parents choose to withdrawal from the 529, it has minimal impact compared to other assets, as noted by Forbes:

Withdrawals from 529 plans used for qualified higher education expenses owned by the custodial parent are not typically reported as parent or student income. Since only a small amount of the 529 plan is counted and none of the withdrawals, custodial parent-owned 529 plans generally have the least impact on your child’s financial aid package. Typically, parents are one of the owners whose 529 plans get the most favorable treatments, so ideally the custodial parent should own the 529 plan.

If the 529 plan is not taken out in the name of the parent, but a relative, say a grandparent, the plan will not be counted as an asset on the FAFSA. However, other withdrawal rules apply in these situations (i.e. the withdrawal from the grandparent’s 529 plan counts as non-taxable student income). For a comprehensive list of these rules, you can refer to this article to get an idea of how it works. But by far the most critical thing to do is to consult your school’s financial aid office. While schools follow federal guidelines, there can also be many institution-specific policies that affect the situation for a student. In other words, never make any major financial aid-related decision without first consulting your child’s assigned financial aid officer. If your child is not enrolled in any specific college yet, financial aid offices often meet with the parents of prospective students (i.e. students who are interested in applying to their school), and it is always wise to schedule financial aid appointments at any of the schools that your child is interested in attending. Call ahead to set these appointments up when you go to visit the campus or attend admissions-related events during the school selection process.

A Roth IRA is a form of individual retirement plan that resembles, except for certain key elements, the traditional IRA individual retirement plan. The more notable differences between the traditional IRA and the Roth IRA lie in the rules that govern their contributions and withdrawals.

Unlike traditional IRAs, contributions to a Roth IRA are “after tax.” This means that contributions to a Roth IRA are not tax deductible but are subject to tax.

On the other hand, eventual withdrawals or qualified distributions from a Roth IRA are tax-free. In addition to the tax-free nature of distributions from the Roth IRA, the earnings on the Roth IRA’s investment assets earn tax-deferred growth. Non-qualified distributions from a Roth IRA, as is the rule for other types of IRAs, could be subject to penalties.

If the taxpayer has attained 59-and-a-half years of age and the Roth IRA has been open for at least five years, then any withdrawals and distributions will be deemed to have attained “qualified distribution” status.

As this article notes, other sets of facts leading to distributions satisfying the definition of “qualified” could be as follows:   

• The taxpayer is disabled

• If the withdrawal is paid out to your beneficiary or your estate after your death

• If the withdrawal meets the IRS "first home" requirements

The ultimate determination as to whether a Roth IRA is a better choice than a traditional IRA largely depends on the expected effective tax rate at the time of distribution. Individuals expecting to have a higher effective tax rate when distributions at the back-end are made may find the Roth IRA more advantageous and profitable since the tax obligation avoided in retirement at the back-end will be greater than the income tax paid on the contribution at the time it is made at the front-end.

In other words, the time value of money invested today, which is not tax deductible, would be less than the time value of money for the Roth IRA asset. This table highlights, to a much larger extent, the similarities and differences between the Roth IRA and traditional IRA.

Are you self-employed and still want an employee matching retirement contribution plan? Well, you can with a SIMPLE IRA.

SIMPLE IRA
SIMPLE IRA stands for "Savings Incentive Match Plans for Employees." It’s a kind of retirement plan tailored for small businesses and they are designed to promote small business employers to offer retirement coverage to their employees. Additionally, they can be used for self-employed people even if they don’t have employees.

There are 2 ways SIMPLE IRA plans aggregate funds; the first is by taking the contribution out of the employee’s salary and secondly, the employer then makes a "matching" contribution. Note that the match doesn’t have to be a one-hundred percent match. If you work for yourself and don’t have any employees, the IRS allows you, the business owner, to pay your max contribution and then you can contribute as the employer matching the contribution. The advantage is that you can, essentially, increase your max contribution—even double it.

SIMPLE IRA Plan Requirements:

• You must have 100 employees or less
• You can’t have any other retirement accounts
• You have to file Form 5500 yearly.
• You (as an employee) and your employees must make at least $5k per year.

Advantages & Disadvantages:

• A SIMPLE Plan is not beholden to the contribution rules that typical 401(k) plans are
• All contributions by employees are fully vested
• Low effort administration method
• Employees have some versatility in regards to hardship withdrawals and options for loans although it’s burdensome for the employer
• You can only have the one retirement plan

Amount of Allowable Contributions and Deductions
A SIMPLE IRA Plan, compared to other plans, allows those with average incomes to invest and deduct more than other plans. When you have a SIMPLE IRA Plan, you’re allowed to invest and deduct all or a portion of your business’s income as someone who is self-employed. As of 2015, the max contribution that is allowed for your employer to take out of your check (also known as elective deferral) is $12,500. However, as you are both the employee (who can contribute $12,500) and the employer (who can match your contribution of $12,500) can essentially make an annual retirement plan contribution of $25k.

If you are over the age of fifty, you can make “catch up” contributions. Over 50, you’re allowed to contribute an additional $3,000 annually.

For instance, if you made $40k, with a SIMPLE IRA, you could invest and deduct $12,500 as your employee status and if you’re over 50, you can invest an additional $3,000 along with the employer match of another $15,500 which is a total annual contribution of  $31k.

If you were to fall into a lower tax bracket, a SIMPLE IRA Plan tax credit up to $2,000 in 2015 for single filers ($4,000 married filing jointly) may be available (also known as the "Saver's Credit"). Your income can’t exceed the threshold of $61k for married filing jointly, $30,500 for those filing single and $45,750 for those claiming head of household.

If you run your business out of your home, SIMPLE IRA plans are a great option. This includes stay-at-home spouses making some income from a side business. Additionally, if the money earned from the side business is not required for expenses, then all the earnings can go towards retirement contributions so long as it’s not beyond the limitations.

A traditional 401(k) does allow you though, the ability to contribute more and contribute more often. For example, if you made $100k, the total you could contribute with a SIMPLE IRA Plan would be $15,500 but if you had a 401(k), you’d be able to contribute $43,500.

Withdrawals from Your SIMPLE IRA Plan
You can withdraw from your SIMPLE IRA as much as you want however, it counts as taxable income and there is a 10% penalty tax for withdrawing early and there is a 25% tax on withdrawals made in the first 2 years of the account being set up.

When a SIMPLE Plan Isn’t The Best
If your self-employment income increases substantially, a SIMPLE Plan isn’t the best option.

Also you don’t directly have control over your investment. It may be best if you went with a something like a Keogh where you are the trustee of the investment. However, most self-employed people’s SIMPLE IRA Plan works basically similar to the SEP-IRA.

There are also plans that allow a deduction for one year when the contribution is made the following tax year albeit prior to the tax filing deadline. This requirement is applicable with SIMPLE IRA Plans as well for the matching (3 percent of earnings) contribution you make as employer.

A good guideline to keep in mind is the quicker your contributions goes into the account, the longer it will work for you without being taxed—delaying is not the most prudent action.

Also prior to the tax-filing deadline, you can’t create a SIMPLE Plan for the year before and claim the deduction as you can with SEPs. A SIMPLE IRA Plan has to be set up by October 1 of that same year unless the business is created after October 1. In this case, the SIMPLE IRA Plan has to be set up as soon as reasonably possible.

Another drawback happens when a SIMPLE IRA Plan is created for a side business and you happen to already be in a 401(k) plan as an employee or in another business. For both accounts you’re only allowed just a little more than the max contribution of the SIMPLE which is significantly less. So, your 401(k) contribution + your SIMPLE contribution cannot exceed $18k as of 2015.

How to Create a SIMPLE IRA Plan

A SIMPLE IRA Plan can be set up on your own by using IRS Form 5304-SIMPLE IRA PLAN or Form 5305-SIMPLE IRA PLAN. However, most people go through financial institutions or a CPA—one familiar with the breadth of their tax and financial situation

An annuity can seem like it’s some word thrown around with retirement and savings on financial ads during football season. Here’s a little help to understand annuities.

Annuities are essentially a savings account that you get from an insurance company. They are set up to ensure that you have money for retirement and can help you stretch money over a couple of decades.

Usually, annuities are bought through, or along with, a life insurance policy. Common knowledge around life insurance is that it helps you make sure your loved ones are taken care of financially if you were to pass earlier than hoped. Conversely, an annuity is a policy that helps ensure you are taken care of should you live longer than you’d thought you would.

Taxes on annuities are deferred until they are paid out. What’s good about this is that there is more money to gain interest from than an investment that can be taxed. It’s important to note that annuities are invested in heavily up front. Then payments are made to you periodically. The payments can be made to you until you pass.

If you live out your life expectancy, an annuity can be an appropriate investment. However, if you were to go too early, an annuity may not be the best investment.

Why an annuity may be right for you

An annuity is practically the definition of long-term investment and almost strictly for that purpose. Also, it guarantees a  steady income for life.

One thing that makes it a long-term investment is the steep penalties for withdrawing finds too early. A ten percent tax can be charged on funds taken out before you reach the age of 59.5. Although, depending on how much the annuity has accumulated, it may be somewhat worth it. Note that the 10% penalty will only be applied to the return on the investment. The thinking is the money you put in was already subjected to taxation.

An annuity can be used for a child’s higher education however, when it’s time for them to use it, they can use it for whatever they want—not just education.

Annuities Options

Single-Premium
The name says it all in this one. You buy the annuity up front in one single payment. Single premiums usually require a minimum of around ten thousand dollars.

Immediate
Immediate annuities trigger payments to you as soon as the annuity has fully vested. Usually from a single-premium annuity. Typically, these annuities as well as single-premium annuities are purchased when a retired individual gets their retirement funds in a lump sum. They then take these funds and purchase an annuity. In the annuity it collects interest and creates a steady and dependable income.

Flexible-Premium
Basically the same as a single premium but breaks the payment up into a series of payments.

Deferred
A deferred annuity doesn’t start payments until way down the road and may come in the form of a lump sum or may come in the form of the typical guaranteed payments that are made periodically.

Fixed
This is a low-risk annuity along the lines of a Money Market account or a CD. The interest yields around 3-5% and the rate is guaranteed for an agreed upon amount of time. The money you invest is usually invested by the insurance company in safer investments such as bonds. This usually looks more lucrative when rates are low but when rates go up in a higher risk investment, that’s money you’re missing out on.

Variable
Essentially, the opposite of the Fixed annuity. This is a higher-risk investment—more along the lines of a mutual fund, which usually carries a growth rate of 12%. Also different from the fixed annuity is the Variable has no guarantee of interest or principal. Variable annuities are still appropriate for long-term investment.

Annuities and Taxes

Whether or not your annuity is a qualified annuity will determine how your payouts are taxed.

An annuity is qualified when it used as a means to fund a retirement plan like a Roth IRA or a 401k. The money you invest is not subject to taxes when withdrawn. Also, in a qualified annuity, the tax on the earnings is deferred until payout.

A non-qualified annuity is purchased with funds after they have already been subjected to taxation. While the tax on the earnings is deferred, the owner of a non-qualified annuity must pay taxes on profit from the original investment.