Get With The Plan: October 4, 2009

10409Enzo and Joyce are managing two households. They own a mortgage-free Shore home and they rent an apartment close to their jobs in Middlesex County.

“How do we avoid paying large sums of taxes? We work hard and would like to maximize our money,” says Enzo, 40. “We are quite frugal and do not need much. We simply want to be comfortable without financial worries.”

They’d like to retire when Enzo reaches age 55. The couple, whose names have been changed, have set aside $187,900 in employer-sponsored retirement savings accounts, $75,000 in a money market and $30,000 in checking. Enzo can expect a pension from his employer worth approximately $111,000 a year when he retires at age 55.

The Star-Ledger asked Vince Pallitto, a certified financial planner and certified public accountant with Summit Asset Management in Florham Park, to help the couple examine their tax options and see of they’re on track for retirement.

“They are in great shape and on track for a comfortable retirement when Enzo turns 55,” Pallitto says. “His pension provides a solid foundation for retirement.”

But the couple’s biggest concern today is taxes. Enzo uses Turbo Tax to prepare their tax returns and he says the software has suggested they take the standard deduction of $11,900 in 2008, rather than itemizing, because their itemized deductions (state and local income and property taxes, out-of-pocket medical expenses, mortgage interest and charitable contributions) were less than the standard deduction.

Pallitto says since they both work in New York, Enzo and Joyce pay their state taxes to New York and get a credit for the taxes paid to New York on their New Jersey return. Their New Jersey tax liability would arise from interest or dividends on their investments.

“As soon as people hear that they have to file income taxes in New York, they automatically assume that they pay more in taxes because New York’s tax rates are higher,” Pallitto says.

He says that’s true for the most part because New York’s rate is 6.85 percent compared to New Jersey’s 6.4 percent. But, Pallitto says, New Jersey is a gross income tax state, meaning it will only allow you to deduct up to $10,000 in New Jersey real estate taxes, alimony paid and out-of-pocket medical expenses that exceed 2 percent of your New Jersey gross income. On the other hand, he says, New York allows you to take itemized deductions much like the federal return.

“Since all of their New York income taxes are offset by their standard deduction, a mortgage payment would be tax-deductible because it would push their itemized deductions over the standard deduction level,” Pallitto says.

Enzo and Joyce are currently paying $1,530 a month is rent and other non-deductible housing costs. A $1,500 a month mortgage payment, in comparison, would be equivalent to borrowing $264,000 at 5.5 percent for 30 years. The couple had been thinking about selling their shore home and buying a larger townhouse in Middlesex County.

“This would be a great way of reducing their taxes,” Pallitto says. “If we assume they net $165,000 after selling expenses, then they could afford a townhouse up to $425,000 without changing their current monthly cash flow.”

If they bought a lesser-valued home, they could add to their savings accounts. The interest portion of the mortgage would cost about $14,000 per year and provide them with $3,920 tax savings, assuming they are in the 28 percent bracket, Pallitto says.

“Of course there will be real estate taxes to factor into the equation but they will effectively get 28 cents on a dollar back in the form of reduced income taxes for every dollar of real estate taxes paid,” he says.

For example, if the larger townhouse has real estate taxes of $5,000 per year, Pallitto says it will generate a $1,400 federal income tax savings.

The home purchase also would allow them to deduct their cash and non-cash charitable contributions, which are currently being offset by the standard deduction.

Turning to retirement, the couple is expecting a hefty pension from Enzo’s job. It will pay him 2 percent of his average salary prior to retirement, multiplied by his years of service. Pallitto conservatively estimates that will be about $111,000 when Enzo is 55. The couple also is saving to two employer-sponsored retirement plans and they’ll also receive Social Security some day.

The pension and their high savings rate will give them a comfortable retirement.

The couple should make some moves on their non-retirement savings. They have $30,000 in a checking account and $75,000 in a money market. Pallitto recommends they put $25,000 in a short-term municipal bond fund to increase their after-tax earnings and set up a more balanced asset allocation model for the remaining $80,000.

“They do not have dividend paying stocks or mutual funds,” he says. “A good portion of the $80,000 should be in large cap value funds that pay dividends that are taxed at the 15 percent rate.”