Planning For An Easy Tax Season...before the holiday rush

I don't know about you, but December has taken me by surprise again this year. And even while I get excited about the holiday parties and our traditional Christmas breakfast of strawberries and biscuits, I am also suddenly aware of those end-of-year deadlines. Unless you've been really diligent this fall, here are some simple tasks that will keep you from following up your holiday recovery with panic attacks:

1. If you are a business owner, you need to think about your annual reports for the state, as well as taxes. Here in Massachusetts the reports are often due in the fall. If you missed the deadline, the penalty is small, but you will want to get those in before they get lost in the taxes. Here is your link to the MA state filing forms & instructions.
2. Planning ahead can often save you on taxes. I know you've heard this before, but this is the moment to actually do something about it. Contact your financial planner or accountant now to see whether it makes sense for you to: sell some investments at a loss (to offset other income); sell some at a gain (if, for instance, you think your tax bracket will be higher for 2016 than it is for 2015, or you would rather pay this year); make some charitable donations or gifts to the family; make a big purchase for the business before December 1; set up a trust.
3. Put a little more in your retirement account. Now that you've reached the end of the year, you may find that you can afford to put a little more money into your 401k, IRA or other active retirement plan. The IRS allows many retirement contributions to be made anytime up until you pay your taxes, BUT your plan may well have an earlier deadline. Make your contribution by December 31st to be sure.
4. Set aside some cash if you've had any unexpected income this year. Most people count on the money deducted from their paychecks to cover the taxes that will be due on April 15th. But if you've received money from a side job, from shares in a business, from the sale of some investments, or if you just received a large gift or prize, you probably owe extra taxes. Plan now to keep some cash aside in your account to cover those. And, if this happens regularly, talk to your accountant about paying quarterly estimated taxes to avoid penalties.
5. Get those receipts together. You probably won't get all of the paperwork you need to file your taxes until January or even February. This stuff includes everything from W2 statements to health insurance coverage certificates and bank or investment tax statements. But you can get your tax receipts in order before the holiday and be ready to turn the whole mess over to your accountant as soon as the paperwork comes in. You will be especially glad you did if you are the tax preparer for your household.

Last but not least, make sure you know who is going to prepare the taxes for you and how. If you are one of those brave do-it-yourself tax filers, go ahead and purchase the tax software now. It's ready and waiting for you.

If you hope to turn this problem over to a professional, keep in mind that these folks get harder and harder to find as April approaches. Ask for referrals to a good accountant in your  area (your financial planner always keeps a list) and make contact now.

When the early spring finally hits, you could be enjoying warm sun and daffodils instead of a shoebox of fading receipts and late night caffeine fixes.

Small Business Realities: What's the Difference Between a 401k and an IRA?

This is one of those questions that pops up routinely. The answer is most important for those of you who own your own business, but it crops up for those who work in small companies, too. So what is the difference between a 401k and an IRA? Well, it comes down to a matter of trust—trust accounts, to be exact.

IRA's are really cheap and flexible

An IRA or "Individual Retirement Arrangement" is just what it sounds like. The account is fully owned and controlled by you, the person who hopes to retire one day. The IRS Tax Code says that, as long as you follow their rules with your "arrangement," they won't ask you to pay income or capital taxes on the money you put in your account until you start taking it out (for more about tax deferral and why it's so great, check "Making Sense of Your Company's Retirement Plan"). The rules here are fairly simple: you need to put the money in a trust for your own benefit. Of course, there are some details, but the banks and brokerage houses have stepped in to cover you there. You can open an IRA account at any average bank or anywhere you would open an investment or stock trading account. And in many cases, it costs nothing to open one. Here is Investopedia's list of no or low-balance IRA account offerings for 2015.

Because the IRS doesn't put many limits on what can go into an IRA account, you can invest in all sorts of things with your retirement money. So, when you do go to choose the bank or broker for your account, check their offerings and ask about things like account management fees or trading fees. We often use different brokerage houses for someone who wants to "sit on" three or four standard index funds as opposed to someone who will be doing more trading.

Use the IRA for you business

Believe it or not, your business can open IRA accounts for your employees instead of a 401k plan. Called a SIMPLE (Savings Incentive Match Plan for Employees), these accounts let you, the employer, contribute money to your employee's IRA accounts without the hassle of a 401k. Cheap, easy and available to any business with less than 100 employees (and no other retirement plan), the SIMPLE only requires you to choose a fixed amount to contribute to your employee's plans—either 2% of her salary each year or a "match" of what she contributes between 1% and 3% of her salary.

The IRA compromise

There is a catch. If you are an ambitious saver, IRA contribution limits might mean that you can't put as much into your account as you like. For 2015 and 2016, your total contributions to both your IRA and Roth IRA can't be more than $5,500 for the year ($6,500 if you are over 55). BUT, if you are contributing to an IRA through your employer's SIMPLE plan, that limit goes up to $12,500 (or $15,500 if you're over 55) per year for 2015 and 2016—and that doesn't include your employer's contribution.

The Great 401k

There are a lot of smaller companies out there that would probably do better with a SIMPLE, but the fact is that 401k's, a type of qualified profit-sharing plan, dominate the U.S. workplace. And there are some good reasons for that. Like the IRA, the 401k is a form of trust account that follows rules laid out in the IRS code  in exchange for tax deferrals.

In this case, though, the rules are more complex and the employer retains a lot more control over what's offered in the plan. And that means some serious compromises for both the employer and the employee.

Employees can only invest their 401k money in what's offered in their employer's plan. If your employer has done a great job sourcing a plan, that should be fine for most people. Historically, though, we've seen a lot of 401k plans that offer expensive and/or limited investments and include high management fees. That leaves employees with a less effective account that can add up to tens of thousands of missing dollars over the course of a career.

Employers also often struggle with their 401k plans. As the employer, you have a fiduciary duty to ensure that the plan is fair and well-managed for your employees. And you have a more complex set of filing requirements so that the government can make sure you are taking that duty seriously. For this reason, it has often been difficult for smaller companies to get a good, reasonably priced 401k plan. Keep in mind that the fees will generally include someone to manage the investments and someone to manage the plan to keep you out of trouble.

Why We Love 401k's

Despite the complexity of 401k's, they remain a favorite even amongst smaller companies. Some of this is just down to the enthusiastic efforts of brokerage houses to sell these plans. But there is a real advantage to the 401k, as well. While the SIMPLE limits employees' contributions to $12,500 ($15,500 if she is over 55), employees can contribute a lot more to a 401k account—up to $18,000 per year for 2015 and 2016 ($24,000 if she is over 55). That extra can mean a lot to the right employee.

The Conclusion

So, which sort of plan works better? As you might expect, it all comes down to the size of the business and the savings ambitions of the employees. If you are an employer, it pays to look at your options. If you go with the 401k, be finicky about the brokerage house or investment advisor you choose—choosing the wrong one can cost you and your employees a lot. And if you are an employee in a small business, don't hesitate to approach your employer if you think there's room for improvement. Most employers don't know any more than you do about retirement plan options and are happy to get better information (especially as it might save her some money, as well!).

If you have more questions about small business retirement plans, send me an email.

Do I Need Life Insurance?

Something about the fall makes people start to wonder about life insurance. I can't explain this phenomenon, but I can give you a little primer on how life insurance works...and doesn't work. Let's start with this, though—a lot of people do not need life insurance. Are you one of them?

First, check to see if you fall into one of these categories:

1. You Are Someone's Financial Support.

The real purpose of life insurance is to fill in for the financial support that one person is providing for others if the provider dies. If someone (your children, your partner, your parents, etc...) is counting on you to provide for them, life insurance probably makes sense. How much the policy is worth and how long you want that coverage for will depend on the costs you are trying to cover.

2. You are a business owner.

Insurance companies provide "key person" life insurance policies to help cover the costs to the business of losing a key employee or owner. Those costs can range from hiring someone to fill the "key person's" place to paying off their family as shareholders, to paying the costs to shut down the business. Notice that unlike the category above, the beneficiary of this policy isn't a person—it's the business, itself. Sole proprietors are generally fine to use a standard personal life insurance policy, instead.

3. You are working with an attorney to avoid estate tax problems.

Trust & Estates attorneys often make use of insurance policies to move wealth to an heir while keeping down taxes. In most cases, this becomes an issue if your estate is worth more than your state and federal estate tax exemptions (an impressive $5.43 million for 2015 for the feds but $1,000,000 for my state of Massachusetts). But imagine you own a large family property or family business, both of which could easily top exemption amounts. Your attorney might talk to you about an insurance policy that allows your family to pay the estate taxes without selling up. As you might have guessed by now, if you are buying insurance for tax purposes start by talking with your attorney, rather than your insurance agent.

Don't fall into one of these three categories? Then you probably don't need life insurance. And that's good news, as it means you can start putting the money you might have spent on premiums into something you can enjoy while you are still kicking around. If, on the other hand, you do think you need life insurance, stay tuned for my upcoming post on understanding the kinds of life insurance out there and how they work.

Are You An Accredited Investor?

I considered calling this post "What The Heck Is An Accredited Investor?" But unless you are hanging out with stock brokers,  you probably don't even recognize the term. That's a problem, because the SEC's accredited investor rule often dictates what you are allowed to invest in and what sort of businesses can afford to ask you for an investment in the first place. The rule has kept our money flowing in certain directions since the aftermath of the Great Depression. And for the first time since then, we are seeing serious efforts made to change it. So what is it and why should it matter to you?

So, are you an accredited investor?

Accredited Investors are the holy grail of ambitious start-ups and private fund managers. If you fall in the Accredited Investor category, the SEC assumes that you can look after yourself (financially, anyway), so many of the careful protections they put in place to keep us all from being squirreled out of our money don't apply to the deals you can make. You would think, then, that you'd have to be very rich or very sophisticated to be an Accredited Investor. The fact is, though, that a lot of well-off but not necessarily "wealthy" people are starting to fall into this category. And it's hard to see where we get the idea that they are all that financially sophisticated.

There are two ways that someone usually qualifies as "accredited":  1. you have at least $1,000,000 in assets (not including your home), OR 2. you made at least $200,000 a year for the past two years and believe you will earn that much next year (the number is $300,000 if it's you and your spouse jointly).  (SEC Reg D, Rule 501).

That first category pulls in quite a few retirees whose pension funds grew over the decades or who inherited retirement funds or property from their own parents. Some of these folks are very sophisticated about money. Most of them probably are not. And while earning $200,000 a year is a great thing, that's not exactly rare or a sign of financial sophistication, either. Sophisticated or not, though, if you are an accredited investor, private businesses, start-ups, hedge funds and other sometimes murky investments are out there looking for you.

Does That Mean I Can Invest In the Next Tech Start-up?

Why, yes it does—maybe. Your Accredited Investor status matters because it means companies can ask you to invest even if they haven't gone through the paperwork and review process that the SEC usually requires in order to sell an investment to the general public.  This can be a very good thing. With SEC public investment filings costing hundreds of thousands of dollars, smaller but equally worthy companies often just can't afford to the process. Limiting themselves to accredited investors means that they still have to follow some basic laws related to what they tell you (and don't tell you), but they don't have to come up with the independent audits and elaborately detailed paperwork. Note, though, that this also means they don't have to make all of that information public for inspection. In other words, it's up to you to make sure you ask the right questions.

What Should I Ask?

You should always ask questions about any investment before handing over your money. But if you are thinking of investing in an unregistered investment as an accredited investor, it's up to you to avoid the Ponzi schemes and the half-baked business plans. You need to ask some extra questions:

1. Who is selling you this thing? Make sure you research the person or company selling you the investment. That might be the company you are investing in, but it might also be an advisor, a hedge fund manager or a broker. Every day the SEC brings charges against people selling fake investments or giving misleading information to investors. Not everyone is caught, but a lot of these names end up on publicly available databases. Start with FINRA's Broker Check site and the Investment Advisor Public Disclosure website to find out more about a broker or advisor;

2. How much will I be charged? A start-up probably won't charge you for giving them money, but a hedge fund definitely will. Be sure you understand any fees you are paying to buy the investment (keep in mind that there might be two layers of fees if there is a broker and a fund involved);

3. How long do I have to leave my money with you? Ask whether your money will be locked in for a period and under what conditions you could sell the investment to get out. Hedge funds almost always require you to leave your money in for a period of time to ensure the manager can follow her long-term strategy. If you invest in a start-up or private business, the only way out will be if someone wants to buy your stake—never a certain event!;

4. How will it make money? Be sure you understand the plan for making money. An investment fund should have a clear, understandable strategy for bringing in returns. A business should be able to show you reasonable (and readable!) estimates for when and how it will make a profit. Make sure you figure in the fees and liabilities to this calculation in case your broker/founder/fund manager doesn't;

5. What can go wrong? If someone tells you there is no risk to an investment, walk away immediately—no such investments exist. Make sure you understand all of the ways your investment could lose value so you can decide how comfortable you are with that risk;

If, after you've asked those questions, you still don't understand something, get an expert. Don't let company representatives, brokers or even your own advisor gloss over the important facts about what you are buying. If the expert in front of you can not make these things clear, or if you are worried that he or she has a conflict of interest, bring in another expert review the materials. Ask an accountant, attorney or financial advisor who is not involved in the deal review the particulars.

For more questions that every investor should ask, check out the SEC's online investor guide.