As financial advisors, we recognize that the outcomes on an income tax return are the culmination of many occurrences and decisions. Tax efficiency is a vital part of a financial plan at every stage, and so we approach tax planning as both a year-round and lifelong process. With that in mind, here are five areas where you might find new opportunities and strategies to manage your taxes, grow your wealth, and attain your goals:
Employer Plans: Whether a 401k, a Thrift Savings Plan, or a 403b account, contributions to these tax deferred vehicles not only help build a nest egg, but also reduce your taxable income in the current year. Lower income in turn may make you eligible for other tax strategies or benefits.
IRAs: Depending on income levels, some workers may be eligible for deductible IRA contributions, or possibly Roth IRA contributions. The former reduces current taxable income, while the latter sets the stage for tax free withdrawals in the future.
Health Savings Accounts: If enrolled in a high deductible health plan, you may be eligible to contribute to a Health Savings Account. Such contributions, as an ‘above the line’ deduction, reduce your gross income in the current year. They can also be invested for growth (account plan permitting), and accessed tax free in retirement when medical expenses are likely to be higher.
Expenses: Business owners are eligible for a variety of deductions, including those for a home office, insurance premiums, and travel expenses, to name just a few.
Retirement Plans: Business owners can establish their own tax deferred savings vehicles for retirement. The type of plan employed will depend upon the number of employees and the level of revenue, among other factors. Owners with no employees might consider a Solo 401k plan, which allows both employer and employee contributions, and thus maximum deductions.
College Savings Accounts: Most states allow deductions, within certain limits, for contributions made into state sponsored 529 plans.
Gifting: Those with highly appreciated securities could consider gifting those shares to adult children, whose income levels make them eligible for a 0% capital gains rate. The child could thus liquidate the security tax-free, and use the proceeds to pay for educational expenses. (Note this is best utilized for a child of at least 24, when something called the “kiddie tax” no longer applies, and is thus often a strategy for funding graduate school.)
Publicly Traded Securities: Shares of appreciated stock, if gifted to a public charity, provide a charitable deduction, and (as an extra tax benefit) avoid capital gains taxes.
Donor Advised Funds: Contributions to these vehicles provide a current deduction while allowing you to wait until a later time to identify possible charitable recipients.
Charitable IRA Rollover: Those age 70 ½ or older can direct the Required Minimum Distribution from their IRA (up to $100,000) to a qualified charity. Channeled in that manner, the distribution is not a taxable distribution, as it would be if received instead by the IRA account holder.
Asset location: Your portfolio may be comprised of taxable brokerage accounts, tax deferred accounts such as IRAs, and tax-free accounts such as Roth IRAs. Generally, growth assets expected to appreciate are better held in taxable accounts, where they will be taxed at lower capital gains rates. Conversely, income producing assets are best held in tax deferred or tax-free accounts, where tax on the income generated is either deferred or avoided.
Gain/Loss Harvesting: Timing strategies, in relation to the sale or retention of assets in the taxable portion of your portfolio, can help in managing your overall tax expense. Securities held at a loss might be strategically sold at year end to offset gains in an otherwise high-income year. When transitioning appreciated securities onto a new portfolio strategy, staggering sales over multiple tax years may preclude you from being pushed into a higher tax bracket in the initial year.
Fee Allocation: Depending upon whether you itemize, investment management fees may be a deductible expense if drawn from a taxable account. A review of your tax return and financial plan can determine if your fees are being taken from the appropriate account or accounts.
The scenarios above arise at different times of the year and in varying stages of life. They reflect just some of the many ways that we pursue tax efficiency while managing wealth and steering our clients towards their goals. Of course, the complexities of individual situations will call for consultation and coordination with a tax preparer. Should you have any questions regarding the tax implications of decisions you are facing or scenarios you are considering, be sure to consult one of our Wealth Managers.
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