Tis the Season …For Year-End Planning
December 2005

What do holiday shopping and year-end financial planning have in common?  Both are best if not left until the very last minute.  In the case of year-end planning, December is the last opportunity to do things that will improve your financial picture for 2005.  What are some of these things?

Status Report to Yourself

The first step to take in year-end planning is to prepare a financial status report to yourself.  Things that you should do in preparing this include:

Your status report then should take this basic information and factor in additional considerations, for example, the likelihood that you will receive a bonus before year end, what amount it is likely to be, and whether or not it can be deferred into a retirement plan or deferred into 2006.  Similarly, you should know whether or not you own any nonqualified stock options that are exercisable in either December or January, and you should know whether you own any incentive stock options that are exercisable before the end of 2005.  If you are self-employed, identify any billings or other income that can be accelerated into December or deferred into January.  If you are over age 70 ½, know where you stand regarding Required Minimum Distributions (RMDs) from retirement plans and IRAs.

Action Plan

Once you’ve made the status report to yourself on things such as those listed above, you’ll be ready to decide what things you might do to improve your financial picture before year-end.  Generally, if your income has been relatively high already this year, you might want to defer additional income into 2006 while accelerating deductions into 2005.  If your income has been low this year compared with expectations for next year, the opposite strategy might be appropriate.

1.  Do your have an opportunity to defer additional income to a retirement plan or IRA?  The current maximum annual salary deferral limits to 401(k) plans are $14,000 for those under age 50 and $18,000 for those over age 49.  These contributions must be made before December 31, 2005.  In 2006, these maximums increase to $15,000 and $20,000, respectively.  The deadline for 2005 IRA contributions is not until April 15, 2006, and the maximum contributions to both traditional and Roth IRAs, for those who are eligible to make them, are $4,000 for those under age 50 and $4,500 for those over age 49.  In 2006, these will be $4,000 and $5,000, respectively.

2. If you have any incentive stock options (ISOs) that are exercisable in 2005, you should run a tax analysis to find out how many of these can be exercised without causing the AMT to exceed your income tax computed without regard to the AMT.  Exercising some of these in 2005 could help you spread the effects of exercising the ISOs over multiple years, thereby possibly avoiding the effects of the AMT each year.  Conversely, you might consider deferring the exercise of non-qualified stock options (NSOs) until January so that the tax on the exercise might not have to be paid for fifteen months (April 2007).

3. “Harvesting” gains or losses can be another fruitful activity late in the year.  Often this takes the form of selling investments that have unrealized losses so as to offset other capital gains realized during the year.

4. Appreciated assets also are candidates for gifting to charities and to individuals who are in a lower tax bracket than yours.  Using appreciated assets for gifts to charities, of course, enables you to make your targeted contributions with smaller amounts of invested cash.

5. Be careful with late year investments into mutual funds.  The funds might have realized capital gains earlier in the year by selling investments within the fund.  These gains might be distributed to shareholders in the fund as of a certain day in December.  If you buy the fund prior to that capital gains payout date, you might be taxed on gains that did not benefit you.  Be sure to find out the date and rate of the fund’s capital gains payout before you make late-year investment into a mutual fund.

6. If you’re going to be receiving a taxable distribution from a retirement plan or IRA, consider spitting the receipt of it into two  parts, on in 2005 and the other in 2006.  If you are due to receive your first RMD before April 1, 2006, consider accelerating it into 2005 so as to avoid doubling up your income next year.  Your second RMD will have to be made by December 31, 2006.

7. If you’re over age 70 ½ and your adjusted gross income is less than $150,000, consider converting your IRA to a Roth IRA so that the assets will be available to you in future years without additional income taxation.

8. Take this time to review your retirement plan and IRA beneficiary designations to make sure they are still appropriate.  Be sure that you don not have an old contingent beneficiary designation to “My Estate” because this could trigger unnecessary taxes after your death under current law.  Consider whether your family would benefit from the designation of a charitable remainder trust or an IRA Management Trust (“stretch” IRA trust).

9. If your parents are living, use the holidays to discuss important topics about their future.  Most older parents are more willing to discuss these subjects than their boomer children are.  Give them the opportunity to discuss their contingency plans for long-term care needs, including the status of their powers of attorney, as well as their desires regarding natural death, life support, funeral arrangements, and other mortality-related issues

10. Finally, if you started the process of year-end planning with a status report to yourself, take this opportunity to expand this into a written status report and inventory to your spouse or other family member.  This will be invaluable to them if you are in an accident or otherwise incapacitated in the future.

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Walt Sheffield is an attorney whose office is in Raleigh, Law Offices of Walter L. Sheffield III, PLLC.  He provides additional law related services in the form of independent financial planning and investment advice through Armor Investment Advisors, LLC, a firm he founded.  Investment advisory services provided through Armor Investment Advisors, LLC are not legal services, and the protections of the lawyer-client privilege do not apply to them.  Securities are offered through Cambridge Investment Research, Inc., a Broker/Dealer, Member NAD/SPIC.  Cambridge Investment Research, Inc. and Armor Investment Advisors, LLC are not affiliated.