It's that time of the year again. Everyone is weighing in with tax tips to prepare investors for the tax preparation that follows the new year. I didn't want to be left out of the fun, so I consulted with John Corn, a certified public accountant and a wealth advisor with Buckingham (with whom I am affiliated). Here are some of the suggestions I have for your year-end tax planning:
1. Maximize your 401(k) contributions. If possible, invest in your company-sponsored retirement plan up to the maximum employer match. If you have the ability to put aside more, you may consider contributing up to the maximum allowable annual amount, which for 2014 is $17,500 (or $23,000 for individuals age 50 or older).
Contributions to a traditional 401(k) plans are pretax, which means it will reduce your taxable income now. However, when you withdraw this money in retirement, those distributions will be taxed at your marginal tax rate at that time. Contributions to a Roth 401(k) plan are made with after-tax dollars. However, qualified distributions from your Roth 401(k) in retirement will be tax-free.
2. Make contributions to a 529 college savings plan. 529 plans are operated by states. They come with tax advantages, as well as other potential incentives, to make it easier to save for college and other postsecondary training for a designated beneficiary, such as a child or grandchild. If you have children or grandchildren, consider funding a 529 account.
Earnings are not subject to federal tax, and are generally not subject to state tax when used for the qualified education expenses, such as tuition, fees, books and room and board. Contributions to a 529 plan are not federally deductible, however some states do allow tax deductions for their residents.
3. Don't forget to take your required minimum distributions. If you are more than 70½ years old, you are required to take distributions from your individual retirement account (and most 401(k) plans). The penalty for failing to take your annual required minimum distributions by Dec. 31 can be severe. If you withdraw less than the minimum required amount, the Internal Revenue Service will penalize you at 50 percent on the amount not taken.
4. Look for tax-loss harvesting opportunities. Review your portfolio for any positions that have unrealized losses, and consider selling those positions to realize them. Does that sound counterintuitive? Well, these losses can be used to offset any capital gains you may have already realized this year. Capital gains can be taxed (at different rates, depending on whether they are short term or long term).
In addition, to the extent you "harvest" more losses than you have gains to cover, you may take up to an additional $3,000 of those capital losses to offset ordinary income. If you still have capital losses beyond that, you may carry them forward and use them to offset income in future years.
5. Rebalance and pay off debt. To the extent you have rebalancing needs in your portfolio, you may well find yourself locking in some gains through your equity positions and rebalancing into fixed income. With interest rates still at very low levels, rather than considering an addition to your bond portfolio, you should consider paying off debt. For example, if you have $100,000 available to invest in a bond paying 2 percent, it may make sense to instead reduce your mortgage, which is charging you interest at 5 percent.
6. Review your beneficiaries. One of the most important planning items to address is a periodic review of the beneficiaries designated in your investment accounts. This review will make sure the beneficiaries you have chosen are still consistent with your overall estate plan. For example, updating your trusts and wills alone may not be enough -- in the case of a life event, such as a divorce or a death in the family -- to ensure assets go where intended. You also need to update the beneficiary designations on your investment accounts.
For IRAs in particular, designating beneficiaries, and, just as importantly, keeping the election updated, are crucial planning steps that can help mitigate the risks of leaving your IRA assets to unintended individuals or entities. This can also help maximize your beneficiaries' distribution options.
7. Make your annual charitable contribution(s). For many taxpayers, charitable contributions are not only way to give to worthwhile causes and organizations. But they are smart ways to reduce taxable income. Contributions to "qualified" charitable organizations are tax-deductible to the donor. You can contribute cash or property. Property can include shares of appreciated securities, such as stocks and mutual funds.
If you contribute securities, you not only get the charitable deduction, but would avoid paying capital gains taxes on the unrealized appreciation. As a result, if you have both cash and appreciated securities available, it often makes more sense to donate the securities, and then invest the available cash back into your account to rebalance your portfolio.
8 . Postpone purchasing mutual fund shares in taxable accounts. Every December, mutual funds are required to pass realized gains from sales of stock on to the investors in the form of capital gains distributions. As a result, it may make great sense to find out when your funds are scheduled to pay out their distributions, and wait until after that happens to purchase new shares.
Good tax planning is an essential part of overall financial planning. However, there is a much bigger issue confronting the majority of individual investors in the United States. And this issue can have a more substantial impact on your retirement planning.
What's the issue? It relates to how you invest your hard-earned money. If you are chasing returns by assuming past performance will persist, picking stocks you believe are mispriced or buying expensive actively managed funds, use year-end planning as an opportunity to fundamentally change the way you invest. By switching to evidence-based investing, focusing on your asset allocation and investing in a globally diversified portfolio of index funds, exchange-traded funds or passively managed funds with low management fees, you will improve your chances of reaching your retirement goals.
Dan Solin is the director of investor advocacy for the BAM ALLIANCE and a wealth advisor with Buckingham. He is a New York Times best-selling author of the Smartest series of books. His latest book is "The Smartest Sales Book You'll Ever Read."
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