Monday, February 17, 2014

Rich Kids, Poor Kids (Part 2)

Rich Kids, Poor Kids (Part 2)
Bert Whitehead, M.B.A., J.D. ©2014

This is the second of three related blogs covering a broad topic:

  • Part 1: A View of our World Through our Grandchildren's Eyes in 100 Years
  • Part 2: Intergenerational Tax and Financial Strategies to Leave a Family Legacy
  • Part 3: The Most Important Lesson to Teach Our Children Now

As discussed in the previous blog, our society is increasingly split between rich kids with a good educational and health foundation, and poor kids with a disadvantaged upbringing likely to hinder their futures. While we can’t restructure dysfunctional families, we can do our best to ease the way for our own children and grandchildren.
We send the best and brightest in our society to Washington to figure out what policies we need to become a better country. Frequently these policies are structured as tax incentives that reward specific financial actions. I believe that those of us who learn about these tax policies and follow the will of Congress are acting in the most patriotic way possible. I suggest three strategies for consideration: Donor Advised Funds, Roth conversions and Intergenerational Strategies.

Donor Advised Funds for Tax Benefits and Philanthropic Options

Donor Advised Funds (DAF) enable individuals and families to set aside funds, tax-free, under the umbrella of a 501(c)3 nonprofit foundation. Most brokerage companies (Schwab, Fidelity, etc.) and many large non-profit and community organizations (Jewish Federation, Southeast Michigan Community Foundation, etc.) offer these DAFs to all individuals at a nominal cost. Each DAF manages its funds, directing contributions to nonprofit groups chosen by the donor(s).

For taxpayers in the top tax bracket, giving $1,000 in cash to a DAF results in a $400 tax saving. However, if $1,000 in appreciated stock is donated to a Donor Advised Fund, the donor saves $400 through the income tax deduction and up to an additional $200 by avoiding the capital gains tax on the appreciated stock.

Our society depends on taking care of one another and these tax incentives make philanthropy more financially appealing. When my family gets together annually, each member identifies a nonprofit organization for a $100 deduction from the Whitehead Donor Advised Fund, and we make the grants online accordingly. When older grandchildren are away at school or jobs and unable to join us, they email me their choices for charities. This is a good way to develop a family commitment to help others.

Roth Conversions

Another way to save taxes for future generations is to convert IRAs to Roth IRAs. The money converted to the Roth IRA is taxed now, and future earnings accrue totally tax-free.  Withdrawals after retirement age are not taxed, and there is no required minimum distribution, which is normally required at age 70 1/2. Upon the death of the taxpayer, the spouse pays no income tax as the beneficiary of a Roth IRA. After the death of the second spouse the Roth IRA accounts can be passed on to their children, who will also receive the distribution from the Roth IRA tax-free. They can then elect to withdraw it gradually, with the minimum required distribution based on their life expectancy at the time they inherit the Roth IRA.

When IRA funds are converted to a Roth IRA, the transferred funds are subject to taxation as ordinary income. Generally conversions are made after significant wealth has accumulated and the taxpayer is in a much higher bracket. This disincentive to elect Roth IRA conversions can be mollified, however, with astute tax planning.

For example, while high income taxpayers are not allowed to contribute directly to Roth IRAs, they can fund non-deductible IRAs (the maximum contribution is currently $6,500 per year). The non-deductible IRA does not provide a tax benefit other than that the earnings accrue tax-deferred. The significant tax advantage is that the IRA can be converted later to a Roth IRA and taxes are assessed only on the accumulated earnings, not the original basis.

Intergenerational Tax Strategies

The creation of a Donor Advised Fund and conversion of an IRA to a Roth IRA can be combined for maximum tax benefit. By establishing a DAF, the tax deductions for the funds contributed to it can offset taxes on the funds converted to a Roth IRA.

Establishing a DAF and utilizing Roth Conversions are very effective ways to pass on our philanthropic values and conserve assets for future generations of our families.

Since these strategies can be somewhat complex, it is important to work with a tax professional to implement them correctly.

Wednesday, February 5, 2014

Rich Kids, Poor Kids (Part 1)

Rich Kids, Poor Kids (Part 1)
Bert Whitehead, M.B.A., J.D. © 2014

This is the first of three related blogs covering a broad topic: reviewing the impact our legacy will have on our children and grandchildren.

·         Part 1: A View of our World Through our Grandchildren's Eyes in 100 Years

·         Part 2: Intergenerational Tax and Financial Strategies to Leave a Family Legacy

·         Part 3: The Most Important Lesson to Teach Our Children Now

Most of us who are baby-boomers or older had grandparents who had no indoor plumbing, no car, and remembered the Great Depression and World War II as personal experiences. Our grandchildren can't imagine we grew up without TV, computers, cell phones, or satellites. Today's children are the first generation who didn't learn their childhood games from their parents, and many of us don't have the technological skills to understand their games -- or even our smart phones.

Think about the world their grandchildren will face. We can't fathom the changes of the next 100 years --- from significant economic upheavals to likely wars with battles that will leave devastation beyond the nightmares we have seen.

Considering the next 100 years compared to the past century forces us to think through what the next generations must do to assure their survival and prosperity. Our parents and grandparents lived in a very different era, and we should think about strategies to further prosperity --- not only for our families but our communities.

Facing the Future

Our children are not likely to be as affluent as their parents. Some say it will be the first generation to be poorer than their parents. The gap between the rich and poor is expanding at a frightening rate.

In addition to the wealth and earning gap of the past 30 to 50 years, there has been a widening educational gap in our country. High school graduation rates, ACT scores, and reasoning and comprehension skills have plummeted until our country ranks 25th among 50 first-world countries, down from #1 during the 1950s. Poor schools get worse and the best schools get more expensive and elite. Additionally, 35 percent of our higher education resources are now devoted to students from China, Japan, South America and the Arab countries, as compared to 5 percent 50 years ago; this is a seven-fold increase.

Even though educational progress seems grim by the standards of our childhood, few of us can match the technological prowess of our grandchildren. It seems that the evolutionary process started hardwiring kids’ brains differently after about 1965. Maybe "being smart" in the 2200s will mean something entirely different in an overwhelmingly technological world, one in which setting up your TV remotes will be considered a simple task.

Indeed, ACT and SAT scores as we know them may become irrelevant in the next few generations. A hundred years ago, a classical education based on theology, philosophy, and languages was considered the cultural foundation for the future. Accelerating changes in critical thinking, scientific knowledge and specialized fields of inquiry require a much more advanced base.

Extended Life Expectancy

Life expectancy was 46 years in 1900 and had increased to 78 years by 2000. As a result, Social Security as we know it will end within a few decades, because there will be too few workers to support the large number of baby boomer retirees. Many actuaries predict that more than 50 percent of the American children born during this century will be centenarians. However, economic and demographic trends tend to be self-correcting. Certainly life expectancy won’t continue to increase unless we address the primary health threats that we face: obesity, sedentary lifestyles and increasing stress.

To summarize, there is a widening gap between the haves and the have-nots, between the educated and the uneducated, and between the healthy and the unhealthy. Many factors contribute to these anomalies; generally the poorest among us not only have the fewest financial resources, but also the least education and the shortest life expectancy. Solving the income inequality issue, the glaring education gap and the health disparities within our society cannot be done independently.

Parenting Skills Are Key

The overriding common denominator between the haves and the have-nots in our society is the quality of their parenting. 40 percent of American children are raised in single-parent homes and others grow up with dysfunctional adults. Even among two-parent households, financial conditions usually necessitate that both parents work so that neither spouse is available to be the primary nurturer and teacher of children.

These children are less likely to have balanced, nutritional meals and may not be taught healthy habits. Children raised in dysfunctional homes are likely to live in an underprivileged environment. Their children will likely also be economically disadvantaged, as poverty is normalized in their world. When basic needs aren't met, the value of education is not paramount.

Of course we alone can’t change the course of mankind. Our primary goal is to do what is best for our own families. We are in a position to influence and reinforce the well-being of our progeny by laying a sound financial foundation. There are perfectly legal tax strategies which our government has designed that enable families to improve their lives and those of their children. I’ll cover these in my next blog.