Take a Year-End Financial Health Check

Article

Dynamic Business Article

December 2000


by Bruce Fenton


"A financial check up will help you cut taxes, cope with market uncertainty, and start a retirement plan."

When it comes to cutting taxes, the three biggest mistakes Americans make are: waiting until December 31 to assess their income for the year; missing out on the latest tax-deferred pension plan benefits, and trading stocks based on tax consequences rather than on value and growth potential.

Assess Annual Income Now
Estimate income for this year now. Those who expect a big bonus may be able to defer payment until next year. Delay exercising stock options until next year, if possible. Small business owners may hold off December billing until 2001 to cut current income. Pay professional expenses such as association dues now. Give old computers to charity. Donate stock that has appreciated to non-profit organizations and take the full value as a deduction. Bunch up costly medical procedures such as dental work. These simple tactics can cut the federal tax bite.
Take full advantage of Individual Retirement Account (IRA) rules. IRAs offer tax-deferred growth and extra retirement saving to meet expenses later in life. Consider a Roth IRA. Roth-IRAs require taxes to be paid for the current year, but the build up and payout at retirement are tax-free. Married couples, filing jointly, may participate in a Roth IRA if income does not exceed $160,000. Limits for single taxpayers are $110,000. Those who have established a Roth IRA and want to convert to an ordinary IRA may do so by tax filing time if income exceeds the allowable maximum.

Don't ignore Education IRAs for minor children. These IRAs allow a $500 deduction per child, which can mount up in substantial tax savings for those in a high tax bracket with several children.

Start a Retirement Plan for Your Business
Small business owners miss out on the biggest tax benefit in America, setting up a retirement plan of their own. While there are 19.2 million unincorporated businesses in the United States, less than 149,000 of them have retirement plans, according to the latest IRS statistics available (1997). These are not people baking cookies or building birdhouses. Total income for these small businesses was nearly one billion dollars, showing that there is sufficient income to fund a retirement plan.

401 (k) and other qualified pension plans available to small businesses are generally more flexible and generous than large corporate plans.
Older wealthy business owners and professionals, whose expenses are lower due to having grown children and paid-up mortgages, may want to consider a Defined Benefit Plan. These plans allow them to set aside enough money on a tax-free basis so that they can receive a retirement income of 100 percent of their annual compensation for life (up to a maximum of $130,000 annually) indexed for inflation. Up to $160,000 per year in compensation may be used for Defined Benefit Plan computations.
With a Defined Benefit Plan, a professional earning $500,000 annually, who expects to retire in less than five years, can set aside the bulk of annual income to create a portfolio large enough to earn $130,000 annually. Younger workers in the company must be included, but the contribution for their retirement plan will be relatively small since their incomes are lower and their time until retirement age is much longer. When the owner retires, he or she may then terminate the plan and purchase annuities to cover the benefit commitment.
New federal
rules for 2000 allow those with a Defined Benefit Plan to also participate in a Defined Contribution Plan and set aside an additional 25 percent of income, up to $30,000 annually in one of several such retirement plans.

Take a Hard Look at Investments

Year-end is a good time to assess your stock portfolio and other assets with regard to age, financial requirements, and risk tolerance. While tax consequences should not dictate investment decisions, consider selling off losing issues (how much you paid for a stock has no bearing on its value today). However, if you do plan to sell at a loss, remember only $3,000 may be applied against ordinary income. It may be best to sell a portion of stock by December 31 and another portion after January 1, 2001.
When it comes to investing for 2001 stick to the basics. Invest for the long term, and base decisions on fundamental business attributes such as sales growth, share of market, and quality of management. Don't try to go it alone, solid advice is available and, unless you plan to be very active in making stock picks, consider professionally managed mutual funds that meet your requirements.

Editors Note: Bruce Fenton is president of Atlantic Financial, specializing in qualified pension plans, 401(k), and financial advisory.