Filing for taxes during retirement may present unique challenges as a result of new income sources and special deductions.  The following article tax filing tips to help retirees overcome the most common difficulties in filing their post-retirement returns. 

Top Tax Tips For Retirees

by Steven Merkel

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There are a lot of great tax breaks for seniors so when you are filing your taxes, make sure you apply for every one you qualify for. The following may apply to you:

• Reduced Capital Gains Tax: For tax years 2011 and 2012, the long-term capital gains tax rate is 15% for taxpayers in the ordinary income tax rate of 25% or higher. If you are in the 10% or 15% ordinary income tax bracket, then your long-term capital gains tax is zero.
• Sale of Residence/Exchanges: If a married couple has owned and lived in their primary residence for two out of the last five years (ending on the date of sale), they can claim a capital gains exclusion of up to $500,000 ($250,000 if single) on their tax return. (Learn more in Capital Gains Tax Cuts For Middle Income Investors.)
• Tax-Exempt Interest/Income: Investments in state and local government securities typically provide federal income-tax-exempt interest to the investor.
• Oil & Gas Investment Deductions: Direct investments in oil and gas partnerships will provide handsome deduction opportunities for the expenses incurred for tangible and intangible drilling costs, allowing the investor a large upfront deduction; typically, the remainder is deductible according to a schedule.
• Qualified Dividends: Investments in companies that pay dividends that trade on a U.S. stock exchange could qualify for favorable tax treatment if the dividends are qualified. If the investor holds the shares for a 60-day period both before and after the ex-dividend date, they qualify for a 15% tax treatment (or )% if the taxpayer is in the 10% or 15% ordinary income tax bracket).
• One-Time Transfer from IRAs to HSAs: You’re allowed to make a one-time tax-free rollover of funds from an Individual Retirement Account (IRA) to your Health Savings Account (HSA). The contribution must be made in a direct trustee-to-trustee transfer. This type of rollover is not taxable as income or subject to any penalties for early withdrawal from the IRA. The transfer is limited to the maximum HSA contribution for the year in which the transfer is completed, and the amount contributed is not allowed as a deduction on personal income taxes like normal HSA contributions. (Find out about these deductions and how you can use them to lower your tax bill, see Increase Your Tax Refund With Above-The-Line Deductions.)

Effective Withdrawal Strategies
When it comes to retirement income, how you withdraw funds during retirement from various savings vehicles can directly impact your taxes. Here are a few pointers to save on taxes:

• Only take the required minimum distribution (RMD) from your Traditional IRA if possible.
• Use taxable accounts (individual, joint, trust) for withdrawing retirement funds.
• Make quarterly tax payments to the IRS to avoid underpayment penalties.
• Be cautious of taking funds from your pension, 401(k) and annuity accounts as this is typically taxed as ordinary income.
• Selecting Social Security early or at normal retirement age will likely effect your taxable income in a given year.
• Direct transfers from your IRA to a qualified charity can help avoid income tax on the IRA distribution - and the withdrawal counts toward satisfying your RMD requirement. (Being generous has never been more (financially) rewarding! See Give To Charity; Slash Your Tax Payment.)

Standard Deduction vs. Itemizing
When you stop working, you’ll have to take a serious look at your situation to determine if you should itemize your deductions or simply take the standard deduction. Upon reaching age 65 or older, you’ll receive an additional standard deduction allowance (on top of the regular standard deduction amount) if you elect not to itemize your deductions. For 2010, the additional amounts are $1,400 for a single filer and $1,100 for a married or qualifying widow(er) filer. In addition, if you or your spouse is legally blind, you’ll each receive another $1,100 allowance ($1,400 for single filer).

Some deductions such as medical expenses, long-term care premiums, mortgage interest, investment and property losses, and charitable contributions might be higher or the same during retirement. Therefore, you might want to continue to itemize your deductions on your federal tax return if your specific deductions exceed the standard deduction limits. (The receipts you cram into your wallet could be replaced with cash come tax season. Check out 10 Most Overlooked Tax Deductions.)

Credit for the Elderly or Disabled
You might be able to reduce your federal income tax by claiming the Credit for the Elderly or Disabled. The primary qualifications include the following:

• You’ve reached age 65 or have suffered a permanent and total disability prior to age 65 while collecting taxable disability income.
• You’re a U.S citizen, resident alien or a non-resident alien who is married to a U.S citizen.
• Your adjusted gross income (AGI) is below $25,000 (married filing jointly) or $17,500 (single filer).

The actual computation of the credit is a pretty simple five-step process. However, it goes beyond the scope of this article and requires the use of an IRS filing status table to determine the starting amount used in the calculation. (Also check out Give Your Taxes Some Credit.)

Taxation of Social Security
While it’s nice to have some additional supplemental income during retirement, it’s important that you fully understand how earned income and tax-exempt interest can affect your Social Security benefits. If you’re married filing jointly and your provisional income exceeds $32,000 ($25,000 for single filers), then a portion of your Social Security benefits will be subject to federal tax.

Provisional income is the total income shown on your return (earnings from a job, interest, dividends, etc.) plus 50% of your net Social Security benefits, plus tax-exempt interest or certain tax-exempt fringe benefits or exclusions.

The Bottom Line
Filing your taxes during retirement can be just as time consuming as when you were employed, so you’ll still need to keep an organized filing system for all of your tax documents to help you better determine whether to itemize your deduction or take the standard return. Preparing for your tax filing can be simple if you work to stay organized throughout the year, and keep abreast of changes to tax laws that could affect your deductions and credits.

Paragon Wealth Management is a provider of managed portfolios for individuals and institutions.  Although the information included in this report has been obtained from sources Paragon believes to be reliable, we do not guarantee its accuracy.  All opinions and estimates included in this report constitute the judgment as of the dates indicated and are subject to change without notice.  This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security.  Past performance is not a guarantee of future results.

As April 15th approaches many individuals have taxes on their mind.  The following excerpt is the key points discussed by Wojciech Kulicki author of the fiscal fizzle in a recent radio interview.

Tips for Tax Time

visit fiscal fizzle to view the complete article and listen to the interview

Key Points

I’d like to rehash some of the main points I made during the interview and things you definitely want to follow up on.

1. IRS Withholding Calculator: If you do nothing else this year, make sure you check in with the official IRS calculator. It’s now updated and ready for the 2011 tax year, and it will help you figure out how much you can expect to owe/be refunded at the end of the year.
2. Mind your family situation. Yes, you should adjust your W-4 now if you’re expecting to get married or have kids this year.
3. You don’t have to be an accountant. Keep your eyes and ears open for the latest law changes and how they will affect your bottom line.
4. But, you HAVE to be a good steward of your own money. Remember—no one cares about it like you do! Figure out systems that work for you and capitalize on that knowledge.

Additional Resources

If you’re interested in learning more about tax time, check out some of the posts I’ve written previously on this topic:

• A more detailed look into the IRS tax calculator.
• My lessons learned from filing taxes for 2008, 2009, and 2010.
• A brief overview of why I use TurboTax.
• The first post I ever wrote in February, 2009—why tax refunds are bad.

Speaking of tax refunds, I just got mine direct deposited on Friday. Have you made time to file your taxes yet?

Paragon Wealth Management is a provider of managed portfolios for individuals and institutions.  Although the information included in this report has been obtained from sources Paragon believes to be reliable, we do not guarantee its accuracy.  All opinions and estimates included in this report constitute the judgment as of the dates indicated and are subject to change without notice.  This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security.  Past performance is not a guarantee of future results.

Mutual funds are a common part of a person’s retirement portfolio.  The following article dicusses the advantages and disadvantages between a small or large mutual funds. 

Does Fund Size Erode Mutual Fund Performance?

by Eric Novinson

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Some investors prefer to invest in smaller mutual funds because they believe that a larger mutual fund produces lower returns. Larger mutual funds most often spend a lower percentage of their money on administrative costs and can pay fund managers more, but they also have to find more companies to invest in, or larger companies to invest in. Small and large mutual funds each have their own advantages and disadvantages.

Research Costs

• A mutual fund’s managers need to research every company in which the fund may decide to invest. If a small mutual fund pays its analysts $10,000 to produce a report on a company, it will also cost a large mutual fund $10,000 to produce the same report. The large mutual fund will spend less on each report in comparison to the amount of money it manages. Even if the large fund researches more companies, if it researches five times as many firms as a small fund but it has a hundred times the small fund’s assets, it still spends a smaller proportion of money on research.

Attracting Investors

• Closing a fund is also a helpful sales tactic, even if it doesn’t affect performance. The reputation of the closed fund improves, because other investors believe it is well-managed. A fund family, which offers several mutual funds, attracts investors to its other open funds when it closes one mutual fund. This explains why the fund managers would close the fund, because they would earn higher fees by managing a larger amount of money.

Liquidity

• A larger fund can buy a large number of shares in a few big companies. Funds usually buy more shares in the companies the fund already owns stock in as the fund grows, because the managers have already ruled out competing firms as poor investments. Purchasing a large number of shares in the same company lowers returns. The large fund will pay a higher price because the stock price will increase once it starts buying shares, and it will receive less income because the stock price will drop when it starts selling shares.

Investment Options

• For a large fund, there may not be enough small companies available to invest in with the potential to provide high returns. If the fund is limited to growth firms, or a single sector such as technology, it will have even fewer investment choices. Some mutual funds, small-cap funds, only invest in small companies.

Paragon Wealth Management is a provider of managed portfolios for individuals and institutions.  Although the information included in this report has been obtained from sources Paragon believes to be reliable, we do not guarantee its accuracy.  All opinions and estimates included in this report constitute the judgment as of the dates indicated and are subject to change without notice.  This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security.  Past performance is not a guarantee of future results.

To succeed over the long term in dynamic markets that are constantly changing and evolving the investment approach must be both disciplined and flexible. The following article takes a deeper look at active money management and some of the advantages of that type of investment approach.

Buy & Hold vs. Active Money Management

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A common rivalry in the financial world is “Buy & Hold” vs. “Active Money Management”. So which one is better? Simple answer…it depends! If you were to look at a long-term chart of the Dow Jones Industrial Average (Figure 1) going back to 1900, then you would see alternating time periods of prosperity and times of stagnation (flat to negative growth). On average these alternating time periods are around 15-years in duration. During the three time periods of prosperity “buy and hold” investing provided solid returns. However, during the three periods of no growth “buy and hold” actually lost money especially during the periods of stagflation (which means no growth and high inflation) which caused significant losses in real returns (returns after inflation).

Figure 1
Sources: Ned Davis Research (Secular Bear Markets), WSJ Market Data Group (DJIA)

Figure (1) specifically shows that the market grew from the low in 1915 to 1929 leading up to the “Great Depression”, approximately 14 years of prosperity. Then during the “Great Depression” from 1929 to 1942 the market averaged an annualized loss of 10%. Then, spurred on by World War II the Dow went from 100 in 1942 to 1,000 in 1966 increasing tenfold during a time of prosperity. From 1966 to 1982, a 16 year period of no growth, the market averaged -1.5% per year. Jump started by Reaganomics, then propelled higher by the tech bubble the market had one of its greatest bull markets of all time. From 1982 through 2000 the Dow went from 1,000 to over 10,000. Finally, year 2000 until present we have experience a net loss after 9 years.

Stagflation in the 70’s
Let’s take a closer look at the previous period of stagflation from 1966 to 1982. (Figure 2) As you can see during that 16-year period there were some significant falls and some strong rallies. In fact, the market decline from 1973 to 1975 was a loss of almost 50%. The following year from the 1975 low of 577 to the 1976 high of 1,000 the DOW rallied nearly 75%. During that 16-year time period there were other extreme falls followed by impressive rallies. A good active money management strategy will thrive during those times compared to the “buy and hold” allocation. The “buy and hold” portfolio would have lost money during that’s same 16-year time period.

Recent Market Events
If you look at the most recent decade since 2000 through to the present day (Figure 2), you will see similar major swings in the market. The DOW from 2000 to the end of 2002 was down nearly 40%. During that same time period, the tech heavy NASDAQ was down over 75%! During the following 5-years, the market nearly doubled with almost a 100% return. Then, the biggest market decline since the “Great Depression” came. From November 2007 to March 2009, the DOW was down over 54%. And most recently, in the last 2-months alone, the DOW has increased over 30%. The biggest two month rally in the last 70-years.
Over the past nine years, if you had your money invested properly, it would have been possible to be more defensive during the bad times, like the bursting of the tech bubble and also during 2008. At the same time, it would have been possible to take advantage of the bull market from 2003-2007 and the recent 30% bounce off the bottom.

Figure 2
Source: StockCharts.com

Advantages of Active Money Management
During the non-growth periods, the reputable active money managers would have most-likely outperformed the “buy and hold” group because of their ability to go cash during the bad times. In turn, being able to get back in the market as the market turned around. To be fair, not all active money managers would have done better than the “buy and hold” managers during those time periods. It is not easy to time when to get in and when to get out of the market. But, reputable active money managers with a solid understanding of technical and fundamental analysis combined with a contrarian mind set, will increase your chances of outperforming the market significantly during times of stagnation and stagflation.

Another major advantage an active money manager has is their ability to spot emerging areas of growth outside of the typical asset allocation, and focus a portion of the portfolio to take advantage of strength in specific sectors. The most recent example of this would be the growth of commodities during 2003-2008. Asset classes like steel, oil, natural gas, coal, fertilizers, etc. outperformed the stock market by over 300% during that same time period. Other examples would be REITs (Real Estate Investment Trusts) from 2000-2005. Real Estate related stocks outperformed the stock market significantly, experiencing positive moves even during the bear market from 2000-2002. Emerging markets from 2003-2008 far outperformed your typical asset allocation during the same time period. Good technicians (chartists) are able to spot and take advantage of new emerging sectors coming off of bottoms.

What’s Next?
I believe we are 9-years into a cyclical 15-year period of stagnation that began in the year 2000. I also believe there is a very good chance over the next year we will see inflation increase because of the amount of money the U.S. government and other governments around the world are spending. If history repeats itself, we will experience extreme volatility. This means we will have powerful moves upward followed by powerful moves downward. If you are in the “buy and hold” camp during this time period, you will be at a serious disadvantage to some active money managers. These money managers will take advantage of powerful upward moves and honing in on the sectors that will outperform during inflationary times. Also, being able to go defensive if the market falls and experiences a prolonged bear trend.

Paragon Wealth Management is a provider of managed portfolios for individuals and institutions.  Although the information included in this report has been obtained from sources Paragon believes to be reliable, we do not guarantee its accuracy.  All opinions and estimates included in this report constitute the judgment as of the dates indicated and are subject to change without notice.  This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security.  Past performance is not a guarantee of future results.

In the following video the difference between buy and hold and active money management strategies are discussed.

Paragon Wealth Management is a provider of managed portfolios for individuals and institutions.  Although the information included in this report has been obtained from sources Paragon believes to be reliable, we do not guarantee its accuracy.  All opinions and estimates included in this report constitute the judgment as of the dates indicated and are subject to change without notice.  This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security.  Past performance is not a guarantee of future results.