They want to provide college educations for their two children, 11 and 8. And then, there’s retirement.
“We hope to live a life that includes extensive travel, living near our kids, giving something back to the community and charity support,” Archie says.
The couple, who are both self-employed and whose names have changed, have saved $677,700 in IRAs, $111,000 in a brokerage account, $100,000 in mutual funds, $94,000 in college savings accounts, $135,000 in personal checking and $300,000 in business checking.
The Star-Ledger asked Vince Pallitto, a certified financial planner and certified public accountant with Summit Asset Group in Florham Park, to help the couple make the most of their assets.
Pallitto says the couple has the same financial goals as most families.
“The good news is that they are on the right track to achieve their financial goals, however, there are several things they can do to reduce their taxes and take home more of their hard-earned money,” he says.
Paying down the mortgage may not be the right strategy, Pallitto says.
“I would not recommend adding the additional principal to their mortgage payment (as they do now) but rather use that money to increase their monthly 529 savings from $600 for both children to $600 for each child,” he says.
While that won’t fully meet their estimated college needs, the couple has other options. Pallitto says as the children get older, they could be paid by the businesses when they are old enough to provide a service. Under the current law, Pallitto says, the first $5,800 of kids’ earned income would not be subject to income tax.
And taxes are the biggest issue for Archie and Roxanne.
“The key to financial planning is developing a plan that maximizes what you keep after taxes,” Pallitto says. “As it stands right now, we are facing the largest percentage tax increases in history in 2013, therefore, there are many things investors should consider prior to year-end such as the pros and cons of converting traditional IRAs to Roth IRAs or taking more than your Required Minimum Distribution from retirement accounts.”
Another strategy would be for business owners to consider reorganizing to minimize some of the expected tax increases.
Pallitto says as it stands today, the Bush tax cuts are going to expire in December 2012.
That means the 10 percent tax bracket will become 15 percent, the 25 percent bracket will become 28 percent, and the 28 percent bracket will become 31 percent.
It keeps going. The 33 percent bracket will become 36 percent and the 35 percent bracket — the highest bracket — will become 39.6 percent.
In addition, long-term capital gains will be taxed at 20 percent rather than the current 15 percent. Dividends, which are taxed at 15 percent, will be taxed at regular tax rates, which could go as high as 39.6 percent, he says.
Also starting in 2013, Pallitto says, if you are married and filing a joint return with income of more than $250,000, or $200,000 for single taxpayers, then “Obamacare surtaxes” can add an additional 0.9 percent on all earned income and a 3.8 percent tax to all unearned income, including the gain on the sale of a home.
“Archie began his business as a Limited Liability Company (LLC) a few years ago after he was downsized from his corporate job,” Pallitto says. “His business had become very successful and has been generating a net income between $350,000 to $400,000, and based on the tax laws of an LLC, all of the income is considered earned income, which is subject to the 2.9 percent self-employed Medicare tax, plus the Medicare Surtax tax of 0.9 percent.”
And given his income level, Pallitto says Archie’s other income would be taxed at the highest rate, and be subject to the 3.8 percent Medicare surtax.
To limit his tax liability, Pallitto says Archie could abandon his business’ LLC status and elect to become an S-Corporation.
“Because he is the only employee, he can implement a 401(k) profit sharing plan for the company along with a defined benefit pension plan,” Pallitto says.
Archie could take a salary of $200,000 from the new corporation, and then defer $17,000 in the 401(k). Given that he’s the only employee, he can match 6 percent from the company on his salary, which is another $12,000, to his 401(k).
Finally, based on his age, regulations allow Archie to defer about $110,000 into a defined benefit plan, Pallitto says.
“If we assume Archie’s 2013 net income is $390,000, Roxanne’s is $18,000 and they have $6,350 of investment income and they continued under their current LLC, they would pay about $94,463 in income taxes plus $1,663 in Obamacare surtaxes,” Pallitto says. “If they implement the proposed changes, they would only pay $44,811 in federal taxes, plus $14,280 of Social Security and Medicare taxes on the wages, but no Obamacare surtaxes.”
That would mean a savings of over $35,000 in federal taxes by implementing the proposed tax-efficient structure, Pallitto says.
Next: retirement savings.
Pallitto says based on their current spending patterns and projected retirement spending, he estimates Archie and Roxanne would need at least $2.5 million.
By implementing the suggested strategies, they would add $142,000 a year for the next 12 years to their current savings, which would bring their assets up to $2.892 million in today’s dollars with a zero return, he says. If you assume a modest 4 percent rate of return over the next 12 years, their savings would be well over $3 million.