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Tax Strategies to Maximize Your Retirement Savings



by Steven Casto

Lower Your Tax

Many taxpayers think that the capital gains rate was cut to 15% in the last round of tax cuts. That’s right, but it’s only part of the story. Many investors qualify for an even lower 5% capital gains rate. How do you get this lower rate?

The 5% capital gains rate applies to taxpayers who are in the 15% marginal tax bracket (e.g. married couples and singles with taxable incomes below $56,800 and $28,400, respectively). While some taxpayers are consistently above these levels, they should not overlook a chance to lower their tax bracket for one year in order to take advantage of a lower capital gains rate.

For example, some people live comfortably on pension and Social Security income. They have been in the 28% federal tax bracket for many years. Because of some recent purchase of property and new mortgage deductions, their tax bracket has dropped to 15%, temporarily. While the 15% regular tax bracket applies to them, they can sell some appreciated assets and enjoy the 5% capital gains rate.

Let’s say a retired couple has $60,000 of income, but they have heavy deductions that year, reducing their taxable income to $30,000. (Other ways to reduce taxable income include using a short-term annuity or tax-free bonds.) Since the 15% tax bracket extends up to $56,800 for married tax payers, filing jointly, they could use up to $26,800 ($56,800 minus $30,000) of capital gains and have them taxed at 5%. Another way

to enjoy the 5% capital gains rate involves gifting stock or mutual funds to a grandchild (who is in the 15% tax bracket), and having the capital gains upon sale taxed at only 5% to him or her.

This may be an opportunity for you to cut your capital gains tax by two-thirds from 15% to 5%, but remember, you need to time the sale of your securities correctly.

Tax Loss Planning

Every year, thousands of investors in stocks and mutual funds miss the benefit of tax loss selling—when an investor has the government share his or her investment losses by reducing his or her taxes.

If you bought a stock at 20 and it’s now 15, even if you plan to hold it for the long term, sell it now! By selling, you can report a $5.00 loss per share on your tax return. Take a deduction (or offset other stock gains) and reduce your tax bill or receive a refund. You can then buy the shares back in 31 days and keep them as long as you like.

If you just sit there with your paper loss and December 31 passes, the government will not share the loss with you. You must actually make a sale to capture the tax benefit. If you miss this each year, you throw away a tax savings and pay more taxes than necessary. Make it a ritual to sell your losers each December and have the IRS share the loss with you.

Annuity Taxation

A woman recently came to see me about converting her annuity to a life insurance policy. Her husband had died four-and-a-half years ago and the annuity had been left to accumulate. Unfortunately, the agent had written the annuity so that the children were the beneficiaries. The wife had no claim to this money! Moreover, the entire interest in the annuity ($280,000) must be distributed within five years of the owner ’s death (IRC section (72) (s)(1)). Therefore, since the end of the five years was near, the entire annuity soon had to be distributed to the children and the tax bill would exceed $50,000!

Had the original agent understood what he was doing, he would have made the wife the beneficiary or the husband and wife joint owners or joint annuitants. This lack of knowledge is causing this family a large premature tax bill. Here’s the point: please obtain annuities from someone who understands the tax ramifications. Has your annuity been written correctly?

Yearly Tax Review

Although you’d like your accountant to give you tax tips, many do not. They simply prepare your tax return and let you go to accumulate another tax bill for the next year. If you seriously want to cut your income taxes, go see your accountant or financial advisor before December 31. Here are the kinds of savings you can uncover:

  • Mutual funds, which are generating too much short-term gains (taxed at higher rates) rather than long-term gains.
  • Higher than necessary IRA distributions.
  • Unnecessary payment of taxes on Social Security income.
  • Opportunities to increase current income.
  • Opportunities to sell securities and avoid capital gains.
  • Opportunities to remove money from IRAs or pension plans at substantially reduced taxes.
  • Improper investment of bypass trust assets, where one spouse has died.


If you are tired of paying more tax than necessary and want to do something about it, you can stop the waste. Don’t think that your accountant has given you the answers unless you ask!

Family Partnership

For years, the wealthy have been using estate planning techniques that may be unfamiliar to many people who could benefit from the same techniques. For example, if estate taxes are a concern, read how you can use a simple device, the “Family Partnership,” to slice your tax bill.

Let’s say that you and your spouse own a farm with a $1 million value. If it is left in your estate, this property could be burdened with estate taxes up to 48% of the value. Wouldn’t it be nice if you could “shrink” the value for estate tax purposes? The family partnership can do that for you.

All you have to do is ask an attorney to draw up a family partnership document, which creates a family partnership (just like you had the attorney draw up a living trust document, which created a living trust). The farm now gets deeded to the family partnership. This is a non-taxable event. (Per the IRS, a transfer to partnership in return for partnership interest is not taxable.) In return for donating the farm to your family partnership, you and your spouse receive 100 partnership “units” in return as evidence of your ownership in the partnership. Think of these units as shares.

Each year, you begin gifting some of these partnership units to your children. You might think that each unit is worth $10,000 ($1 million divided by 100 units). But here’s the best part. For estate tax purposes, the farm inside the family partnership is worth less— let’s say $700,000 in this example, and each partnership unit is worth (for tax purposes) only $7,000 in the hands of your children. (The actual discounted value is ascertained by an appraiser who is experienced in setting discounts for family partnership assets.) Why is there a discount?

The IRS allows a valuation discount for two reasons. The first is “lack of marketability.” The IRS agrees that the units you gift to your children are virtually unsellable to anyone. Secondly, your children have no control over the farm. This is called the “minority interest” discount. As a result, the farm value for estate tax purposes is now only $700,000! You have just wiped out $300,000 of estate value (a potential estate tax savings of $144,000) by forming a family partnership.

But the partnership has other benefits. Let’s say someone falls off a ladder working on your house and sues you. Your assets in the partnership are protected from suits and creditors. (Claimants only have “charging orders” in states that have adopted the uniform act.) Even though the partnership units may be gifted away over time to your children (to remove the value from your estate), you can remain the lifetime general partner. That means you are always the boss. You decide how the farm gets managed, whether to sell it or borrow against it or whatever decisions you choose to make. It’s all in your control.

For a combination of estate tax savings, protection from creditors and ease of estate distribution, a family partnership can be a very powerful tool.

What is a Gift Annuity?

Periodically, someone who sold some stock or property earlier in the year wants to know what he or she can do to offset the large tax bill created by the sale. While planning before the sale provides a lot more options, there is still a way to save tax after the sale with a gift annuity.

A gift annuity results by making a gift to a qualified charity, but you get income from the gift for life and you get an immediate tax deduction that can be used to shelter the tax from your real estate or stock sale. Let’s look at an example. 58

Suppose Mr. Jones, age 70, sells a property for $100,000 that has been fully depreciated. Let’s simplify and assume a tax due of $15,000. Can he shelter this tax? Yes.

He can set up a gift annuity. He contributes the $100,000 of his proceeds and receives a $6,500 annual income for life (of which 59% is considered a tax-free return of principal and not taxed until the gift is recovered). In addition, he receives a tax deduction of $38,660 right away. Look what he has accomplished:

  • He has offset part of his capital gains tax with a tax deduction of $38,660
  • He generates a lifetime income of $6,500 annually, partially tax-free.
  • He benefits his favorite charity

It gets even better if Mr. Jones does not need the income today. He can defer it. If he defers the income for ten years, his income will increase to $ 14,647 per year and the tax deduction increases to $88,883.

The same technique can be used to shelter taxes from an IRA or retirement plan distribution, while still providing an annual income. Since the annual income from a gift annuity is based on age, the older the contributor, the larger the income.

If interested, a qualified advisor can provide a quotation of income and tax savings for your situation.

Sell Real Estate and Avoid the Tax

Do you have a single –family rental property that was purchased years ago with big gains? It may not be convenient, but if you and your spouse move in and live there for two years, you can then sell and avoid tax on the first $500,000 of gain ($250,000 for a single taxpayer). In fact, you could unload a whole portfolio of rental houses, and possibly do so tax free, by living in each for two years before selling.

Do you own an apartment building that you no longer want to care for and want to go live in France for a year? You can exchange the apartment building for any other investment property, such as ownership of say, a McDonald’s location (a hypothetical example to illustrate the concept). Under a triple net lease, McDonald’s (or the franchisee) take total responsibility for the property. Your monthly rent check can be deposited in your bank account as you travel through the Bordeaux region. (Note: when you exchange real estate, you do actually exchange one property for another. You sell your property and those funds go immediately into escrow for the new property you are purchasing. Such an exchange is tax-free).

Maybe it’s time to get rid of those 500 acres of farm land that doesn’t make any money. You can donate it to a charitable trust, and as the trustee, sell it tax-free. Then you can invest the money as you see fit in stocks or bonds, receive a hypothetical 8% payout (or a rate you select based on IRS limits), lifetime annual income from the property out of your hair and out of your estate (and at the same time create a nice donation for your favorite charities when you pass on and a nice tax deduction for yourself).

The tax rules provide flexibility when it comes to real estate. It’s easy to harvest profits and avoid taxes in many situations.

Mutual Fund Turnover Costs

Many investors own mutual funds, but few of them realize how much they really earn after taxes. Here’s a little insight from Creating Equity by John Bowen. In a study commissioned by Charles Schwab and conducted by John B. Shoven, professor of Economics at Stanford University, and Joel M. Dickson, a Stanford Ph.D. candidate, taxable distributions were found to have an impact on the rates of return of many well-known retail equity mutual funds.

The study measured the performance of 62 equity funds for the 30-year period from 1963 through the end of 1992. It found that the high-tax investor who reinvested only after-tax distributions would end up with accumulated wealth per dollar invested equal to less than half (45%) of the funds’ published performances. An investor in the middle-tax bracket would see only 55% of the performance published by the funds.

Another study, by Robert H. Jeffrey and Robert D. Arnott, published in the Journal of Portfolio Management, concluded that extremely low portfolio turnover can be a factor in improving a fund’s potential after-tax performance. Asset class funds typically have very low portfolio turnover, which translates into less frequent trading and, therefore, may result in lower capital gains. Low turnover also may benefit shareholders by holding down trading cost.

In plain English, the above studies indicate that you can lose a lot of your returns from mutual funds to taxes and that funds with high turnover tend to generate higher taxes for you. You can find out how tax-efficient your funds are by consulting information services available in many local libraries or consulting a financial advisor experienced in the tax issues of mutual funds.

Lower Your Capital Gains Taxes

There are at least four ways to eliminate or defer capital gains tax upon the sale of an asset. These ideas are outlined for you below.

  • Before the sale, donate the asset to a charitable remainder trust and have the trust sell it and then provide the income to you.
  • Donate the appreciated asset to a personal foundation and have the foundation employ you or your family members (in addition to doing good works in the community). Take a tax deduction for the donation.
  • In the case of stock, you can exchange shares of stock for an interest in a specialized small business investment company (SSBIC)—essentially a mutual fund of small company stocks. Thus, you can diversify what may be too much money in one stock for an interest in several, and thereby reduce your risk. If these new shares are held until death, no capital gains tax is paid.
  • In the case of real estate, an unwanted old apartment building can be exchanged for a chain location on a triple-net lease (e.g. McDonald’s). You eliminate all management headaches, as the chain has full responsibility for the property. You get a nice rental income check each month and if the property is held until death, there is no capital gains tax.

Want a Significant Tax Deduction?

If you would like to generate a significant tax deduction, consider giving away your house, but don’t move out!

Many charities will work an agreement with you to take your house as a bequest when you pass away, and yet provide you with the charitable deduction this year. You continue to live in your house for your lifetime, yet have the benefit of saving tax dollars this year (and possibly into future years). So if you have been thinking about a significant charitable contribution, this may be a painless alternative for making a contribution to your favorite charity. If you leave your house through your will or trust, you get no income tax savings. If you make the arrangements now, then you could save tens of thousands of income tax dollars. That’s money you can spend now.

You can achieve some of the estate tax benefits and leave the house to your heirs, at a discounted estate value, by using the Qualified Personal Resident Trust (QPRT). This type of trust splits the value of your residence into two parts—the value represented by the time you will live in the house during your lifetime and the “remainder” value that you leave to your heirs. The present value of this remainder interest can be a heavily discounted figure for estate tax purposes. The smaller your estate is calculated to be, the lower the estate tax. Consult a legal advisor for more information about this option.

How to Lower Your Social Security Taxes

As retirees well know, the federal government takes back part of your Social Security through taxes. Depending on your level of income, the tax can be levied on up to 85% of your Social Security benefits. Can you beat the tax? Yes, many can and here’s how.

The general approach is to defer income. Deferred income does not appear on your tax return, it is not part of your taxable income. Therefore, deferred income can reduce the amount included for the Social Security benefit tax calculation. 62 Tax-free income will not reduce the tax on your Social Security income, because tax-free income is included in the IRS Social Security tax calculation. Here are your sources of tax-deferred income:

Deferred Annuities: Some investors shy away from annuities, because they have the mistaken impression that all annuities tie up their money. In fact, annuities are issued in terms as short as one year. Reinvested interest is all deferred and such an investment can reduce or eliminate the tax on Social Security income.

Certain Zero Coupon Bonds: There are a few issues of corporate zero coupon bonds that have tax-deferred status. (Even though E-bonds are tax-deferred, the IRS specifically includes them when calculating the taxes on your Social Security income.)

Can a Trust Help with Taxes?

There are as many kinds of trusts as there are flavors of ice cream. Many can help save taxes. Here are a few ideas:

Personal Residence Trust: Think of your house as having two portions of value—the time you spend living in your home for the rest of your life and the value of the home after you die that you leave to your heirs (the residual value). It’s the second portion that is part of your estate and potentially subject to estate taxes. The IRS allows you to give that portion to your heirs now at a discounted value to potentially save estate taxes.

If you are familiar with the concept of “present value,” you know that one dollar, 20 years from now, is only worth 45 cents today (discounted at 4%). Therefore, you can place that discounted residual value in a trust now and remove it from your estate. If you are alive at the end of the trust term, you will need to pay your heirs rent to live in your house because technically, you will no longer have any right to ownership or right to reside there. If the trust outlives you, you have potentially saved a fortune in estate tax.

Grantor-Retained Income Trust: This type of trust works similar to the above except that rather than placing your house in a trust, you place other assets—stocks, funds, investment property. Again, you remove the future value of the asset from your estate today.

Private Annuity Trust: This works for passing real estate to heirs and deferring capital gains tax. For example, you could make an apartment building that you own and place it in the trust in exchange for a note. The trust sells the building (and owes no capital gains because the basis and the sales price are the same). The trust invests the money and makes payments to you on the note. You pay capital gains tax as you receive each payment and spread the taxes over years.

At your passing, the note is extinguished and the assets in the trust pass to your heirs, estate tax free.

These are just three ideas using trusts that can keep the IRS away, increase your financial security (assets in trust are usually protected from your creditors) and increase benefits to family.


Excerpted from Is Your Retirement Heading in the Right Direction? by Steven Casto. Copyright © 2005 by NFC and Steven Casto. All rights reserved. Excerpted by arrangement with Steven CSasto. $19.95. Available in local bookstores or click here.

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