Beating Uncle Sam

This post assumes as of its writing that tax-reform does not happen for the 2017 tax year.

TaxesMadeSimple….yeah, right! When I think about one of the key values we offer clients at PDS Planning, tax planning is certainly near the top of the list. We help clients routinely make their tax return more efficient. In most cases, these strategies need to be executed by year-end. Before we cover some of more advanced topics, let’s touch on the low-hanging fruit first.

IRA Contributions: The deadline for these contributions are not until April 15th of next year, but should always be considered if you have made the necessary contributions to your company’s 401(k) to receive the employer match, and if you have ample emergency reserves, and if you have an income low enough to make either a deductible or Roth contribution.

HSA Contributions: Health Savings Accounts are wonderful. If you participate in a High Deductible Health Insurance Plan (HDHP), then you are eligible to contribute and have until April 15th of the following year to make these contributions. Let me add a twist though…rather than contribute, then use this account to pay medical expenses in the short-term, save your receipts, invest in a long-term strategy such as the ones offered from Health Savings Administrators, and allow those earnings to compound free of tax, and take your withdrawals down the road, matching receipts you gathered along the way. Remember, your HSA may receive contributions through an employer-chosen provider, but you can transfer these assets to an administrator of your choice anytime. An often overlooked strategy that really allows you to beat Uncle Sam!

Tax-loss harvesting: Not all losses are bad. You are typically allowed to only deduct up to $3,000 per year on your tax return for investment losses, however an unlimited amount may be carried forward and used to offset future gains. If you sell something for a loss, be sure to avoid the wash-sale rules by not buying back the same security for 30 days.

Tax-gain harvesting: That’s right, the opposite of harvesting a loss. If you are in the 15% federal taxable income bracket or lower, your capital gains are federally income-tax free. Here’s how it works. Let’s say you own 10 shares of a stock that you bought at $10. Today, the stock is worth $15. You could sell the stock, realize a gain of $5 per share, immediately buy it back, and if you’re in the 15% bracket or lower, you owe no income tax, and have a new cost basis of $15 per share. That $5 gain you originally had will never be taxed!

Roth IRA conversions: Another consideration would be to convert some of your pre-tax IRA amounts to a Roth IRA. Yes, you pay ordinary income taxes on the amount you convert, but you will be removing all future gains from your federal income tax liability. The most often-asked question is whether your tax rate is higher or lower today than you expect it to be when you make your retirement withdrawals. Here’s the answer: we don’t have any way to know for certain! For those struggling with that uncertainty, here is the best analogy I have heard to date – this is political diversification.

Nondeductible IRA contributions: If you are ineligible to make either deductible or Roth IRA contributions, consider making an after-tax (nondeductible) one. Contribution limits are the same ($5,500, or $6,500 if age 50 or older). The earnings will continue to compound in a tax-deferred manner. Let’s add a twist to this as well. If you have no other pre-tax IRAs out there,  you can consider at a later date converting these after-tax contributions (and related earnings) to your Roth IRA. The only caveat is that you must pay income tax on the earnings portion that is converted, but all future earnings are now in your Roth IRA!

None of these strategies on their own are terribly significant, but tax-planning that has real impact is that which is typically done in the aggregate, each year. Over time, those benefits build to have real meaning for your wealth. Though taxes are not simple, taking advantage of tax benefits is. It’s just WealthAdviceMadeSimple.