Good investors are good tax planners.
Tax planning isn’t as fun as investing — or fun at all — but it helps you keep as much of that hard-won investment income as possible. Dan Solin, a wealth advisor with Buckingham and director of investor advocacy for the BAM ALLIANCE, shares eight tax-planning tips for investors.
Maximize your 401(k) contributions.
If possible, invest in your company-sponsored retirement plan up to the maximum employer match. If you can put aside more, consider contributing up to the maximum allowable annual amount ($18,000 in 2015 or $24,000 for those age 50 and older). Remember: Contributions to a traditional 401(k) plan are pretax, which means they 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.
Put your money in a 529 college savings plan.
Earnings are not subject to federal tax and are generally not subject to state tax when used for 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.
Don’t forget to take 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.
Look for tax-loss harvesting opportunities.
Review your portfolio for any positions that have unrealized losses, and consider selling those positions to realize them. 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.
Rebalance and pay off debt.
In addressing the rebalancing needs in your portfolio, you may 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, 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.
Review your beneficiaries.
Do a periodic review of the beneficiaries designated in your investment accounts. This review will ensure 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 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 keeping the election updated are crucial steps that can help mitigate the risks of leaving your IRA assets to unintended individuals.
Make your annual charitable contributions.
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 you 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.
Postpone purchasing mutual fund shares in taxable accounts.
Every December, mutual funds are required to pass realized gains from sales of stock on to investors in the form of capital gains distributions. As a result, it may make sense to find out when your funds are scheduled to pay out their distributions, and wait until after that happens to purchase new shares.
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