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Managing Income: A Bourne Identity

Coin Dropping Into Piggy BankWouldn’t you agree that a solid and sound financial planning process must include some Advance Tax Planning (ATP) strategies? If you are shaking your head yes right now, you are ahead of the game.
 
Recently, a very nice couple from Bourne came to see me, let’s call them Bob and Linda. Bob is 72 and Linda is 71 and they are both retired. They receive a combined amount of about $30K annually from Social Security. Bob also has a pension, which pays them $50K per year. Bob has $825,000 in a Traditional IRA and since he is over age 70 ½ he must take his Required Minimum Distribution (RMD), which is considered taxable income. This year Bob’s RMD will be about $32K, which he has not taken yet. So, if no strategies are used to reduce the amount of Bob and Linda’s combined taxable income (which is listed on page one of their federal income tax return, IRS Form 1040, for 2013), it will total approximately $112K. Bob and Linda came to me seeking independent financial advice to minimize their 2013 income tax liability.
 
Bob and Linda are planning wisely. With taxes on the rise, and the future of Social Security uncertain, it is essential to manage income on page one of Form 1040.. Unfortunately, many times I find that folks associate financial planning only with investment strategies. But sound financial planning must incorporate Advanced Tax Planning strategies to help reduce unneeded tax consequences, which thereby increases income. Makes sense right?
 
Back to Bob and Linda. Through the discovery stage of our meeting, I learned that Bob and Linda do not rely on the entire amount of their RMD to pay for ordinary living expenses. I also learned that Linda is a breast cancer survivor and that they give about $20K each year to the National Breast Cancer Foundation (NBCF). I asked Bob and Linda how they have been advised to pay for their past charitable donations. Bob told me that in the 7 years with his current advisor, they never discussed charitable deduction strategies, in fact, Advanced Tax Planning was never discussed. I asked them if they would like to learn how to reduce the amount of Bob’s RMD, which is deemed taxable income for both federal and state tax purposes. The answer was, “Heck yeah!”
 
I explained to Bob and Linda that earlier this year, Congress renewed the special tax break for “Qualified Charitable Distributions” (QCDs) when it passed the 2012 American Taxpayer Relief Act (ATRA). A QCD is an otherwise taxable distribution from an IRA (other than an ongoing SEP or SIMPLE IRA) owned by an individual who is age 70½ or over, that is paid directly from the IRA to a qualified charity. An IRA owner can exclude from gross income up to $100,000 of a QCD made for a year, and a QCD can be used to satisfy any IRA required minimum distributions (RMDs) for the year. Also, the amount of a QCD excluded from gross income is not taken into account in determining any deduction for charitable contributions.
 
Unfortunately, while many of the provisions of ATRA are permanent, the QCD provision is not. It actually will expire at the end of this year unless Congress takes some action. I told Bob and Linda that because Congress could decide to abandon the QCD provision altogether, now is the time for them to take advantage of this provision.(If the QCD provision does expire, Congress could eventually bring it back. However, that would require Congress to act, which is something that Congress has had difficulty with in the recent past.)
 
I advised Bob and Linda to pay the $20K to the NBCF directly from their IRA, rather than from their checking accounts. Doing so will reduce the amount of Bob’s RMD (which, as explained above is taxable income), thereby decreasing the amount of income taxes paid to Uncle Sam. I explained to Bob and Linda that to qualify, the distribution must be paid directly from Bob’s IRA to the NBCF..
 
I was very happy to help Bob and Linda, and was satisfied knowing that through just a small amount of planning they will reduce their income taxes. I hope that by sharing Bob and Linda’s story, as well as others, you, my Cutter Family Finance readers, are also benefitting. It is hard to believe that for just over 6 months now, you and I have come together weekly through this column to discuss financial issues, large and small, all of which impact our family’s lives. My hope is that you understand that a successful financial plan must include not only a secure investment strategy, but also solid planning for the implementation of tax, income, legacy, and estate strategies.
 
I have enjoyed the time we spend together each week and look forward to our future. Cutter Family Finance readers, you, have a thirst for sound information and a hunger for knowledge. I truly believe that your financial future is bright. See you next week.
 
Be vigilant and stay alert because you deserve more!
 
Image by © Royalty-Free/Corbis