Farrell is even unhappy that those baby boomers who have been responsible are getting free ride. For example, the report recommends elimination of the mortgage interest deduction. Farrell laments that boomers won’t be affected because many of us have already paid off our mortgages.

We even take a hit from Farrell for the proposal to increase the gas tax. He thinks we get off easy because we won’t be driving as much when we are older.

Deep down Farrell must believe that boomers who have accumulated significant net worth over years of hard work should now be compelled to disgorge some of it to the government to help reduce the deficit, i.e., redistribute it to others.

Farrell summarizes his rant against boomers with this:

When all is said and done, Boomers may end up shouldering more of the burden to pass a sustainable government to future generations.

If this is really going to happen, it needs to happen with the estate tax, not by extracting our wealth while we need it to live on. I’m no fan of the estate tax but it will be easier for us to minimize its impact compared to fighting off attempts to tax us more while we are alive.

Actually, it’s doubtful that anything substantial will be done in response to this report. Fourteen of the eighteen commission members have to approve the report for it to become “official.”  It does not appear that the votes are there. After that, Congress will have to implement the proposed changes, i.e., stop their free spending. Spending is what politicians do to get votes.

I just hope that folks like Farrell don’t get the drums beating louder with a “let’s stick it to the boomers” message.

Here is a link to the complete article: The Debt Commissions Free Ride for Boomers

To read the commission report, go here.

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The first step, of course, is to max out contributions to your tax-deferred retirement accounts, e.g. 401(k), 403(b), and IRA. If you are lucky enough to have money left over to invest in a taxable account, here are some suggestions:

1. Own tax-free and/or tax-deferred investments. Your options here are somewhat limited and include municipal bonds and muni bond funds (tax-free) and I Bonds (tax-deferred).

2. Own individual stocks and exchange-traded funds (ETF). Conventional mutual funds can generate taxable income through dividend and capital gains distributions. This can occur even if the NAV of the fund has not increased over the year and even if you choose to reinvest the distributions. Individual stocks may produce dividend income but they will not trigger a capital gain unless and until you sell. An ETF is far less likely to make a capital gain distribution.

3. Own index funds not managed funds. The “geniuses” who manage funds are inclined to do a lot more buying and selling of investments inside the fund compared to a fund that merely tracks an index. These transactions tend to generate more taxable distributions for fund owners.

4. Offset gains with losses. As you get closer to retirement, re-balancing and re-allocating of assets in your taxable portfolio may be necessary to reduce risk. Look for opportunities to do this in a way that allows you to sell losers so as to offset taxable income generated in your other investments. Then pull the trigger to save you tax dollars.  Capital losses can be used to offset all capital gains. Up to $3,000 in capital losses can even be used to offset taxable income that is not a capital gain.

As we approach the last quarter of the year, start thinking about whether any of these strategies can decrease your tax liabilities.

Does anyone have other suggestions to share?

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The expected tax increases arise from expiration of the so-called “Bush tax cuts.”  Unless the November elections create a seismic shift in political power, most or all of those tax cuts will disappear. This will result in the following tax increases:

1. The lowest personal income tax bracket will increase from 10 percent to 15 percent. This is one increase that even the Democrats will probably stop.

2. The second lowest tax bracket will increase from 25% to 28%. Because this is considered a “middle class” bracket, action may be taken to stop this increase.

3. The 28 percent tax bracket will increase to 31 percent. Since this bracket includes income in the $84,872 – $177,006 range for single filers, and because President Obama promised no tax increases for those making less than $250,000, this increase may be stopped as well.

4. The 33 percent tax bracket will increase to 36 percent. If you are a high-earning baby boomer, expect your paycheck to shrink unless the Republicans prevail.

5. The 35 percent tax bracket will increase to 39.6 percent. See number 4.

6. The death tax will return after a brief moratorium. Estates of $1 million or more are going to be taxed at a rate of 55 percent instead of 0%.

7.  The long term capital gains tax will increase from 15 percent to 20 percent. This of course will make investing in equities and real estate less attractive for retirement savers.

8.  The tax on dividends will increase from 15 percent to 39.6 percent. This is huge for retirement planning. It will substantially reduce net dividend income to retirees. It will also make stocks with high dividend yields less attractive, lowering their per share value relative to other stocks.

9. The marriage penalty tax will be reinstated. The “marriage penalty” arises when a married couple filing jointly pays more in taxes than two separate earners filing separately, but with the same combined income. The law that treated married couples fairly is scheduled to expire. If it does, plan for a larger tax bill and maybe adjust your withholding accordingly.

Another quasi-tax increase you can plan on is increased health care insurance premiums. Most health care economists expect health insurers to increase premiums more than usual to compensate for increased costs associated with “reform” legislation passed in 2010.

It is not too soon to look at your spending and income budget for 2011 so that you can make adjustments that may minimize the impact of these tax increases on your retirement planning.

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To pay for the health care reform legislation, the bill included new taxes on “unearned income.” This includes investment income, interest, dividends, royalties and even rental income. Annuity income is included within the definition of “investment income.”

The original bill that passed the Senate and more recently the House included a new 2.9% tax on unearned income. The more recent reconciliation bill increased the new tax rate to 3.8%.

The new tax on unearned income will be imposed beginning in 2013. The 3.8% tax applies to investment income received by married couples filing a joint return (and surviving spouses) and having a taxable income of at least $250,000. The tax will also apply to married taxpayers filing separately with an income of $125,000, and to other single taxpayers with an income of $200,000.

The new tax will continue present law and will be applied only to income that is currently taxable. For annuities, that means only income that is above the owner’s cost basis. For a life annuity, this considers your life expectancy. (More information about taxation of annuity income.)

Although the annuity industry will work hard to get this tax repealed, I would plan on the tax being around when baby boomers retire.

If you have or are considering purchasing an annuity for retirement, keep this tax in mind when putting together your retirement income plan. If you are fortunate enough to have a six-figure taxable income when the annuity begins, you will pay the extra 3.8%.

More taxes are likely coming for retirees who plan and invest well and will have some wealth to show for it. Tax planning will be increasingly important for them.

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1. Vanguard Enters the Guaranteed Lifetime Income Space

The first problem is one of tax planning. If you regularly receive a tax refund, you are not planning properly. Rather, you are extending an interest free loan to the government.

Why would you want to do that?

If you want to lend your money out at no interest, find someone more deserving. Better yet, why not invest that money into your retirement nest egg?

I never receive a tax refund. I always owe more taxes to the government. My issue is walking that fine line between sending a check on April 15 and being hit with an under-withholding penalty. That’s where my year-end tax planning occurs.

Some folks argue that over-withholding is really a forced savings strategy. According to this “logic”, because they never see the money, they won’t spend it.

Sorry, that is unpersuasive.

It would make much more sense (and make you more money) to direct deposit that extra withholding into a high-yield savings account. Make it an account that does not come with an ATM card or check-writing privileges and you are good to go. Let the bank hold it for you – and pay you interest – instead of letting the government use it for free.

The second problem associated with tax refunds is that people tend to treat them – and spend them – as “found money.” They consciously or sub-consciously pretend that the government sent them an end-of-year bonus. So they take that “bonus” and treat themselves to a vacation or some frivolous purchase.

It is not a bonus, folks. It was your money all along. You just were not careful about who got to use your money all year. Some folks make it worse by accepting a “refund anticipation loan” from an overpriced tax preparation service.

File online yourself. Take that refund and immediately invest it for your retirement. If you have consumer debt, use the refund to pay that debt down.

One good retirement investment option is to direct that your refund be used to purchase I-Bonds.

The final step is to contact your payroll or HR department and adjust your 2010 withholding so that you do not receive a refund next year. Before you go, use this IRS withholding calculator to determine what adjustments you should make.

Plan to succeed and you will.

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If you want to learn more about the benefits of using I Bonds for retirement, read why I like I-Bonds and the research behind the retirement income plan I developed.

The new and easy I Bond purchase method comes from your federal income tax refund. (You were planning on investing that refund money, right? After all, you let the government use it interest free in 2009!)

This is how you claim the refund:

1.  Decide how much of the refund you want to allocate toward the purchase of I-Bonds. Right now, there is an annual purchase limit of $5,000 per person using this method.  The bonds purchased from a tax refund will be issued in paper form.  You can purchase an additional $5,000 in electronic bonds but not using your tax refund.

2.  Download or use IRS Form 8888. This is the form that tells the IRS that you want to direct your refund electronically to more than one account. I Bonds are sold in $50 increments, so unless your refund is an exact multiple of $50, you will have other refund money to account for.

3.  Enter the amount of your I Bond purchase in line 1a of the form. Also enter the routing number (043736881) and account number “bonds.”  Check the “Savings” box.

4.  Enter information for direct deposit of the balance of your refund in line 1b.

After you receive the paper I Bonds, you may open a Treasury Direct account and have them converted to electronic form.

Here is the link to IRS Form 8888

Give this I Bond purchase plan some serious consideration. Five or ten years from now, you will be glad you did.

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If you are eligible for the retirement savings credit, your credit rate can be as low as 10% or as high as 50%, depending on your adjusted gross income. The lower your income, the higher the credit rate.  Your credit rate also depends on your filing status (single, married or head of household.) The maximum credit is $1,000 for single filers and $2,000 for married filers.

You are not eligible for the credit if your adjusted gross income (AGI) exceeds certain amounts as follows:

• $27,750 as a single filer
• $41,625 as head of household
• $55,500 if married filing jointly

To claim the credit, your contributions must be to a qualified retirement plan. These include a traditional or Roth IRA (but not rollover contributions), 401(k), SEP-IRA, SIMPLE IRA, the federal Thrift Savings Plan, or a 403(b) plan.

Also, you are disqualified from the retirement savings credit if any of the following apply:

• You were a full-time student for any five months in 2009 (not including online-only schools)
• You were under 18
• You were claimed as a dependent by another taxpayer.

Also, if you took a pre-retirement distribution from a qualified retirement account, that distribution will offset the credit.

The retirement savings credit is not refundable, so if you do not pay federal income taxes, you will not benefit from the credit.

To claim the credit, you must file IRS Form 8880 with your Form 1040 or 1040A.  You can download Form 8880 and instructions here.

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A smart entrepreneur has started BIDaWIZ. This online service connects consumers and business owners online with personal finance and tax professionals using a unique “I can answer your question for $xx” process. Seriously.

When you need a professional answer to a specific personal finance or tax question, you select the category, ask the question, then wait. Your question is submitted to multiple “wizards” who have been qualified to respond to your question. The wizards are CPAs, CFPs, or other credentialed financial advisors who have been accepted into the BIDaWIZ system. Those wizards who want to answer your question will submit an “Offer of Service which will include the following information:

• Credentials – Education, Professional Licenses, Work experience
• Customer Ratings – Number of questions answered and average rating
• Offer Expiration – Time until offer expires
• Est. Time of Delivery – Estimated time to receive answer
• Offer Amount – Fixed fee for providing service

Note that last part – a fixed fee for the service! How cool is it to know ahead of time exactly what you will have to pay to receive a professional answer to your personal finance or tax question?

To consider your options, you will receive an email notifying you when a bid is submitted. Then it is up to you to select a wizard (or not) and then move on the complete the engagement, all online.

I have not tried the service yet but it has received good reviews from others. If you want to learn more about having personal finance professional bid for your work, check out BIDaWIZ here.

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1. Sell Some Losers. If you own stocks or mutual funds in taxable accounts, you can sell the losers to offset any capital gains for the year. If your losses exceed your gains, you can deduct up to $3,000 of your net capital loss against 2009 ordinary income (salary, self-employment incomes, alimony, interest, etc.  Any additional net capital losses can be carried forward to 2010.

2. Time Stack Your Deductions. If your itemized deductions are typically close to the standard deduction amount, consider accelerating and bunching itemized deduction expenditures every other year. Using this strategy, you itemize in some years to deduct more than the standard deduction, and in alternate years you claim the standard deduction. This can save you a bunch in taxes over time, depending on how variable your tax rate is. Deductions that you can bunch or accelerate can include mortgage interest, property taxes, work-related expenses and even some medical expenses.

3. Prepay College Tuition. If you still have kids in college and you qualify for American Opportunity or Lifetime Learning higher education tax credits, consider this: Prepay tuition that is not due until 2010 if that would result in a bigger credit on this year’s tax return.

4. Plan Major Purchases for Sales Tax Deductions.  If you live in a state with no personal income taxes and you itemize, you have the option of deducting either state and local sales taxes or state and local income taxes on your 2009 return. So if a new car or boat is on your list, it may pay off tax-wise to buy it this year. Also, the federal stimulus plan created a temporary deduction for state and local sales and excise taxes paid on new vehicles purchased between Feb. 17 and Dec. 31, 2009. The deduction is limited to the actual taxes paid on the first $49,500 of the vehicle purchase price. You can claim this deduction whether or not you itemize.

5. Earn Tax Credits from Home Improvements. If you have been thinking about some energy-saving home upgrades, now may be the time to pull the trigger. A variety of improvements qualify, such as replacement windows and doors or a new HVAC system can earn you up to $1,500 in tax credits.  To learn more about what qualifies for energy tax credits, visit the government’s Energy Star site.

6. Adjust Last Paycheck Withholdings. Now would be an excellent time to estimate your 2009 tax obligation and compare it to your actual year-to-date withholdings. Adjust up or down as needed to minimize your refund (free loan to the government) or to avoid an underwitholding penalty.

7. Maximize Your Retirement Plan Contributions. To lower your taxable income, contribute up to $5,000 per year to your deductible IRA ($6,000 if you are over 50). The contribution limit for 401(k) or 403(b) plans is $16,500 or $22,000 if you are age 50 and older. Try to bump up your contribution rate as needed at year end to hit your yearly limit. You can then lower it after Jan. 1.

I hope some of these year-end tax planning ideas are applicable to you. Do you have any strategies to suggest to me?

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1. Roth IRA. This is perhaps the easiest way to set up a source of retirement income that is tax free. That’s because you pay taxes at your current marginal rate on all income that you put into the Roth IRA. A big obstacle to funding a Roth IRA has been income limits. Those limits disappear in 2010. This can make it attractive convert a traditional IRA to a Roth.

2. Roth 401(k). Less available and even less well-known is the Roth 401(k). Some 401(k) plans and administrators permit employees to designate part or all of their 401(k) contributions as Roth contributions so that all withdrawals from the Roth component are tax-free. You can have both regular and Roth contributions in the same 401(k) account, with the understanding that the total combined contributions cannot exceed the annual limit. A key distinction between a Roth 401(k) and Roth IRA is that the former is not subject to income limits. A taxpayer is entitled to have a Roth 401(k) and a Roth IRA in the same year. For more information, read this IRS publication on Roth 401(k) rules. Before you do anything, check with your plan administrator to confirm that your plan has the Roth feature.

3. Municipal  Bonds. Most investors know that municipal bonds generate income that is free from federal income tax and also from state income tax in the state where the bonds are issued. Although muni bonds and funds took a hit in 2008, they have begun to recover. The tax equivalent yields of muni bonds are now generally better than that of Treasury bonds, which is a good indicator. To calculate a taxable equivalent yield, divide the muni  bond’s yield by 1 minus your marginal tax rate and compare that to a similar Treasury security. Of course, to minimize default risk through diversification, you need to own a variety of munis. That can be expensive. A better route may be through a municipal bond fund or ETF.

4. Cash Value Life Insurance. Some baby boomers still own whole life insurance policies that we bought when we were younger. These can now have substantial cash value. Keep in mind that if you access that cash value, that portion which represents a return of the premiums you paid over the years is tax-free. Check with your insurance company to get the specific numbers.

5. Residential Home Sale Capital Gains. If you sell your main home to downsize or to relocate to a less expensive area, you can exclude up $250,000 of your capital gains from taxes. ($500,000 if you are married). That is a fantastic way to generate spendable income tax-free. If you have a second home or vacation home, the rules on capital gains taxation have changed.

6.  Pension and Annuity Income. If you have a cash basis in an income annuity or pension (meaning that you contributed to it), some of the income that you receive will not be taxed. This IRS publication breaks it down in detail.

7. Social Security Income. If all of your retirement income comes from Social Security, you probably won’t pay any taxes. Hopefully you will have other income. The rules on taxation of Social Security benefits if you still work can be hard to understand but here is my attempt at explaining it.

When you are putting together your plan to have at least some tax-free retirement income, be wary of the impact of required minimum distributions (RMD) from retirement plans which kick in at age 70 1/2.  Because RMD rules do not apply to Roth IRA and Roth 401(k) funds, they are ideal tax-free income sources.

Good luck with your tax-free retirement income planning!

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