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Get Ahead With Tax Planning Strategies for Next Year

Are you hunting for last minute ideas and strategies to reduce your tax bill? If so, consider spending that time preparing to reduce your tax bill for next year. It will be a lot more productive to take steps now that could reduce the tax bill for 2016 than to trying to hunt for some donation receipt. Here are a few strategies to consider going forward:

Get a handle on your income tax brackets: If you convert a portion of your IRA into a Roth, or you periodically cash in savings bonds, or if you have a taxable investment account or you can control when you recognize income, it’s critical that you understand your income tax bracket thresholds and plan throughout the year. Recognizing income (through a conversion or sale) can bump you up into a higher tax bracket and you end up paying more in taxes. Sometimes that tax can be steep and costly, affecting your income taxes, your social security taxation, and even your Medicare premiums!

Tax Loss Harvesting: If you have a taxable account, you are well aware of how frustrating it is to own an investment with a huge unrealized gain and don’t want to sell it because of the tax it will generate. The solution is to sell it in coordination with one or several investments that have underperformed. The gain and loss can offset each other. 2015 was a particularly great year to do tax loss harvesting, but we won’t be that lucky in the future.

Gifting Strategies: If you’re charitably inclined, consider giving gifts of appreciated stock. You get a tax deduction AND avoid paying capital gains on the stock. If you’re over 70.5, you can make direct charitable contributions from your IRA which can offset your annual Required Minimum Distribution.

Should I Pay Down Debt or Invest in the Market?

As individuals approach retirement they often ask themselves what they should do to maximize their income. Specifically, they may wonder if they should pay down their debts (credit cards, auto loans, or a mortgage) or should they invest more in the markets. The answer is often times more complicated than they expect.

Exploring Investments

It’s important for investors to understand what the after-tax cost of borrowing is, especially when a mortgage with interest rate is involved. It’s possible that after-tax returns can be higher than after-tax cost of debt. Borrowers who pay a low interest rate are in a better position to invest. Other factors that determine whether or not someone should invest instead of pay down debt favor the entrepreneur and people who are willing to take risks. An investor with a loan costing them 2% per year may want to keep that debt and instead invest in the market if they think they can get 5%-6%.

Managing Risk

Risk is determined by several factors such as age, income, time frame, market activity and taxes. Most experienced investors are aware that equities can be high risk assets. A leading factor that favors investing is high disposable income, which allows for higher risk tolerance. If we revisit the above example, the investor does run the risk of investing in the market in a bad year. In that case the investor still has to service the debt, but also watch their portfolio decline in value. The higher the interest rate on the loan, the more risk the investor takes that the return on the investments will not beat the interest rate.

Paying Debt & Cash Flow

Even though debt seems like a bad word, it is helpful to a credit score to have a certain amount of debt or credit history. The first priority should be saving up six months worth of monthly expenses as part of an emergency or safety net fund. Once this fund is in place, excess money can be used to pay down debt or invest. The main barometer for deciding between debt and investing is debt-to-income ratio. If the ratio is high, paying debt is usually the wiser choice. Tight cash flow is a red flag that budget cuts will be needed.

 
With low interest rates like we’ve seen, now is a good time to review your situation.

How to Reduce the Pain of a Required Minimum Distribution

When the government enacted legislation that allowed individuals to fund a Traditional IRA with tax-deferred income, those legislators also wanted to ensure that the taxes would eventually be paid. The concept was to defer income taxes until the time the money may be needed for retirement.

To ensure that the deferred taxes would eventually be paid back during the saver’s lifetime, a Required Minimum Distribution (RMD) of the balance commences when the individual turns 70 ½. The first year’s RMD is approximately 4% of the total of all tax-deferred IRA balances. Following that, the RMD percentage increases each year during retirement. The penalty for not withdrawing the RMD can result in a substantial penalty of 50% of the shortfall.

Below are a few strategies to consider that could help to reduce the pain of an RMD:

Plan Ahead

Individuals who will continue to accumulate substantial income from pensions and other sources can consider withdrawing portions of their IRA soon after age 59 ½, but only to the extent that the withdrawals do not force a higher tax bracket.

Defer Social Security

In some cases, deferring Social Security until 70 while using your IRA if needed up to that time can yield dual benefits. The RMD reduces while maximizing the Social Security benefits that increase each year that starting payments are deferred.

Conversion to Roth IRA

Converting portions of your existing traditional IRA into Roth IRAs before age 70.5 will allow the balance to continue to grow tax-free. Though taxes must be paid at the time of the conversion, subsequent withdrawals from the Roth IRA will be non-taxable.

Charitable Donations

Donating an amount equal to the RMD to qualified charities will offset the calculation of the taxable income.

Reinvesting into an Investment Account

One of the more popular strategies is to take the RMD, pay the taxes and reinvest the rest into a brokerage account.  Investors can keep their money working for them.

Contact us if you’re interested in discussing any of these strategies.

When Clients Spend Through Their Savings

A reporter from Financial Planning Magazine, recently posed a question to several financial advisors asking:

“What happens when an elderly retired client runs out of money?”

Below is my response, which was included in the article:

 

WATCH WITHDRAWAL RATES

Michael Lecours, an advisor at Ohanesian/Lecours in West Hartford, Conn., says the time to address the issue of running out of money with retirees is when they start increasing withdrawal rates from their savings.

“We can see the writing on the wall five to 10 years away,” Lecours says. “After a conversation, most clients recognize the issue and find ways to reduce their expenses. They make plans to downsize, move in with a family member, or scale back on their lifestyle.”